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Needle in a stack

Since the qualitative ratings service was brought out by Standard & Poor&#39s Fund Research five years ago, it has quickly risen to become one of the most powerful institutions in the UK fund management industry.

Today, many IFA firms – including, most notably, Chase de Vere – will not put a fund on their buy-list unless it is A, AA or AAA-rated, despite the fact that S&P makes it clear that its ratings should not be used as a trading statement.

Hargreaves Lansdown head of research Mark Dampier believes that much of the power of the ratings has come from an increasing compliance burden. He says: “All the IFAs use them because they get compliance off their necks. To be fair to S&P, they have got themselves into a position of incredible strength by accident. It is actually the IFAs and the FSA that have made them stronger.”

Holden Meehan marketing director Graham Hooper says that while it is not ideal that ratings hold the power that they do, it is perhaps the best workable option. “I do not think it is perfect but it is probably the best some IFAs can do with the resources they have. You would need a huge team to be able to analyse the whole fund universe yourself,” he says.

While most fund managers support the principle of a qualitative ratings system, it has become increasingly difficult for S&P to be thorough and consistent across such a large range of funds. Yet, despite this, whether an investment group&#39s funds hold S&P ratings significantly affects its new business volumes.

Furthermore, fund companies are forced to pay S&P per rating that they receive, leading some frustrated fund managers to label the system “cash for ratings”. Perhaps unsurprisingly, none were willing to give such comments on the record.

S&P argues that it remains impartial in its ratings, pointing out that fund managers pay in advance at the start of the year based on an estimate of how many funds S&P thinks it is going to rate.

S&P European head of research James Tew believes that although his firm&#39s ratings should not be used as the only source of fund research by IFAs, they are a useful tool.

He says: “They should look at ratings because it gives them a better understanding of the fund. We screen the universe and bring it down to a manageable size for them.”

Regardless of impartiality, S&P&#39s business model forces it to rate a certain quantity of funds each year to sustain its revenue levels, regardless of whether all those funds deserve a rating. Equally, as the number of fund managers moving between firms has increased, S&P has been forced to ease its ratings criteria to ensure that it has enough funds to rate.

Only one in five funds can now boast the same manager for more than five years. Hence, while funds once had to have a three-year track record to be rated, new launches are now eligible, based on a fund manager&#39s previous track record. This ignores the fact that a manager may not perform in a new environment.

Tew says: “If a fund manager has a track record elsewhere, we can take that into consideration. If he goes to a similar group with a similar style, he could possibly achieve a similar rating but we make it clear these are new fund ratings.”

But Rothschild Asset Management director Bambos Hambi, who heads the firm&#39s multi-manager operations, says he disagrees with new ratings and has often been frustrated by the consistency of the regular ratings. He says: “This time last year, they retained Invesco European&#39s AAA rating despite a dreadful year. Then, this year, instead of downgrading it to an AA or A, they scrapped it altogether. These ratings should move by an A at a time.

“The biggest problem we have had with them in the past is that they did not take into account style. Recently, they have been trying to amend that and Dresdner&#39s American fund recently kept its rating, despite bad numbers, because of its style. But we have not seen any other evidence of that outside the American sector.”

S&P&#39s power has been magnified by the fact that, as yet, no competitor has presented a viable challenge. If even a giant such as S&P can suffer from lack of resources, the smaller qualitative ratings agencies have not had a chance. All this may be about to change, however.

Earlier this year, Forsyth Partners teamed up with Old Broad Street to launch a new comprehensive qualitative ratings service, which has received the backing of all the industry&#39s biggest players. Its principal attraction for the fund managers has been that there is a set fee for the service, regardless of how many funds it has rated.

Nevertheless, any new venture will take some time to build up a brand equivalent to S&P. Hambi says: “I welcome a competitor. I think there has been a hole for some time. But if you look on their site, it is very basic and I do not think the researchers do a very thorough job. They just do not have the resources.”

Whether or not the likes of Forsyth/OBS will ever topple S&P, there is certainly now a greater pressure on S&P to provide a watertight service for its customers. Some even believe that, as a result, it will soon be forced to rethink its entire business model.


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