Is an AAA rating worth more than five stars? If a fund is downgraded from AA to A, is this worse than being downgraded from five stars to three?
The relationship between fund management companies, ratings agencies and intermediaries has historically been one of mutual dependency. A good rating from Standard & Poor's Fund Services (still referred to nostalgically as Fund Research), Micropal or Old Broad Street Research gives a fund management group a marketing story.
It implies that the specific fund has been the subject of intense scrutiny and thorough research by highly qualified investment professionals who have put the marketing veneer to one side to concentrate on the true fundamentals and process of the fund.
For intermediaries, using these ratings reports and referring to the ratings themselves have helped to take away some of the due diligence issues and helped with content for reasons-why letters. Intermediaries take the research ratings as completely independent and are therefore not contaminated by the marketing slant of the fund management groups.
So does this relationship work today and how have things changed?
Various ratings agencies have different fee models but in general the fund management companies pay the ratings agencies for the work that they carry out on an independent basis. This means a fund management company could, in theory, write out a six-figure cheque each year to have its funds independently badly reviewed.
Two and a half years into a bear market when all costs are under scrutiny, there is no other area of business where a marketing director would pay money to an independent body for proactively saying bad things about their investment process.
S&P Fund Services had virtual monopoly position until the arrival of Old Broad Street Research with its new approach based on charging an all-inclusive group fee rather than a fund-by-fund fee.
For intermediaries, it has generally been all good news. Years ago, receiving the big white books from Fund Research cost in the region of £9,000 per year. As the costing model has changed from the intermediaries paying for the research to the fund management companies stumping up the cash, the cost to the intermediary has reduced to zero.
The use of websites and the updating of information has removed the need to have a full time assistant collating updates for various sector analysis which arrived week by week.
Good news then for intermediaries and for company librarians who have now been freed up from their former onerous task.
But what about the fund management companies writing out the cheques to fund the research from the ratings agencies? If the pricing model is not on an “all-in group fee” then bizarrely fund groups are sent an invoice and told to pay, quite often for funds that they have no intention of marketing and which rely on the periphery of their fund range.
Most ratings agencies' reports contain a “comment” which they generally insist is the key part of the report. For intermediaries and fund management companies, the key is the number or letter of the rating.
With the total cost to each group with a good performing fund escalating, with no visible reward in terms of new business, it is time for this whole subject to be reviewed.
At one extreme there must be dangers of drifting into the “cash for ratings” area when getting new funds assessed. Conversely, spending thousands of pounds on small emerging market funds and non marketable products clearly needs reviewing.
The industry needs to answer two basic questions. If ratings agencies did not exist, would we invent them today? If we did, who would pay for the research?
Ian Chimes is managing director of Credit Suisse Asset Management