WITH THE LAUNCH OF A RATINGS SERVICE AIMED AT BREAKING Monopoly held by S&P, we LOOK AT the factors which will ensure success or failure
The onshore qualitative funds ratings service launched last week by the partnership of Old Broad Street Research and Forsyth Partners has been given between 12 and 24 months to prove itself of use to the funds industry.
The web-based service has been set up as a direct attempt to break Standard & Poor's effective monopoly on qualitative ratings on funds for the intermediary market.
Unlike Lipper, Morningstar, Micropal and now the FT which all carry quantitive ratings, the new group aims to win users from S&P Fund Research, long the giant and benchmark of the qualitative ratings industry.
The service, first reported in Investment Week, is supported and indeed launched at the instigation of a broad raft of fund groups looking for a lever to reduce S&P's charges. It offers intermediaries an alternative and, as with S&P ratings, intermediaries can access it via the internet free of charge.
Backers that have so far been named are Aegon, First State, Schroders, Aberdeen, Lazards, M&G, Franklin Templeton, Axa, Investec, Newton, Framlington, Merrill Lynch, BWD Rensburg, New Star, ABN Amro, Invesco Perpetual, RSA Investments, Threadneedle, Gartmore and Standard Life. The sheer size of assets under management of these houses shows the support that Forsyth-OBSR Partners has.
The comparison table (top right) looks at the differences between the two services to identify the points on which Forsyth-OBSR could either succeed or fail to persuade intermediaries that it is the fund selection tool to unseat its respected rival, or simply to establish itself as a lasting rival by winning intermediary users.
In order to rival S&P, the new service will have to achieve significant rollout.
The history of the service's establishment is an uneasy one. Last year, fund providers were angered when S&P upped its charges by some 40%, raising the amount paid by larger groups to around £100,000 to have their funds rated.
The groups sought talks with S&P, which convinced them that the fee rises would pay for wider and higher profile distribution of the service, most notably internet roll-out, something S&P has delivered on.
The damage had been done, however, and the groups sought out Old Broad Street Research, which already provided onshore fund research, and Forsyth Partners which did likewise in the offshore market, using its recommendations to build multi-manager portfolios.
The two groups have some impressive industry names, those noted for their fund ratings skills. Old Broad Street boasts Richard Romer-Lee and Mike Harris, while Forsyth has Tracy Pearson, Peter Toogood, Jacqueline Aldhous and the recently-recruited Dean Cheeseman, who joined from Quilters where he ran the group's multi-manager portfolio operation.
Keen to say that the service is here to stay, Paul Forsyth, chief executive of Forsyth Partners, said: 'The fund providers know this venture cannot succeed on a two to three month timescale. They have got to get confident with us. They understand Old Broad Street and they understand Forsyth Partners, so they do not have an issue on the investment research process. The question is whether the ratings will be accepted in the marketplace.'
Already, the signs are encouraging. Chase de Vere, one of the UK's largest intermediary firms has already expressed its admiration for the service. The IFA group went as far as to say that it is looking to integrate the Forsyth-OBSR service into its own research process alongside its use of S&P. Until it and other groups have integrated the new service into their research platforms, no real victories will have been won, however.
Romer-Lee said: 'It may be that this is just a lever to get the price of ratings down but no industry should be content with a monopoly. It is not just price issues we are talking about.'
His statement reveals a lot about the relationship between fund raters and the fund groups. Their relationship is symbiotic, each needs the other. Establishing a workable arms-length relationship is not easy when one funds the other. It has to be remembered that the ratings are free to intermediaries, leaving the fund providers to carry the bill.
Given this the pricing structures of a ratings service must be transparent and not appear to compromise on independence.
Forsyth-OBSR has sought to get around that with an arms length fee structure. S&P fees are assessed at the start of the ratings cycle based on the number of funds a group has that pass the S&P quant screens. This is a structure that Paul Barnes, product development director at S&P, defends as ensuring full independence. S&P does not allow groups to select which funds are assessed for ratings.
By contrast, Forsyth-OBSR uses only a flat fee, with a different level for large and small groups, with no component for the number of funds assessed.
Additionally, Forsyth-OBSR will rate funds from the entire funds universe, regardless of whether all fund providers pay. Payment assures the groups' usage rights in advertisements and marketing material.
At S&P there was a long-running difference of opinion between Artemis and the rating group. Artemis held out and refused to pay, undermining the claim that the service covered the whole market. Artemis has since backed down. Its UK Growth and UK Smaller Companies funds now have AA ratings.
Barnes has questioned the sustainability of the Forsyth-OBSR Partners business model, likening it to the model initially used in the US by S&P. It simply did not cover its costs, according to Barnes.
In response, Forsyth Partners said it made no secret that the increase in its brand awareness would be useful in expanding other business areas such as its fund of funds business.
Questions have been asked about the resources each group has. Under European head of research James Tew, S&P boasts 70-plus analysts. Forsyth-OBSR has just 15, three at OBSR and 12 at Forsyth.
Romer-Lee discounts this difference. 'It is not a numbers game,' he said. 'Our people are investment professionals right across the board. They understand investment.'
It is on the research process and the intermediary community's assessment of its analysts that Forsyth-OBSR will survive of fail. The core investment research proposition of the two groups also differs in some key areas. The most notable, and the one that has caused greatest concern to product groups, is the use of past performance.
No-one questions the quality of S&P's research and its widespread intermediary usage indicates that it is seen as a valuable tool. By its own calculation, 71% of all the funds it rates AAA, AA or A, go on to outperform their peer group average over the three years following rating.
Despite this, it has long been a bone of contention that S&P uses past performance screens to cut down the size of its rateable universe. If a fund is not in the top 20% of funds on past performance within its peer group over the past three discrete years at the point the fund is due to be rated, it will not even be considered.
S&P has moved in recent times to undo the perception that, for example, value funds are penalised when they underperform in growth markets by being compared in the quant screens to growth funds. Using value, blend and growth peer groups is an innovation to be introduced in its forthcoming North America ratings review.
In a move instituted in recent years, S&P began to award AAA(new), AA(new) and A(new) ratings to funds without a lengthy track record or to funds with a new manager with an impressive track record. This overcame criticism the group risked missing the profitable early years of a fund's development.
Past performance screen use has caused concern among fund providers which maintain that in a qualitative service past performance is irrelevent. If a qualitative ratings group likes a fund, its manager, investment process and fund provider one month, performance should not alter that view.
Forsyth-OBSR has no such absolute screens in its use of past performance in its research process. Statistical analysis is present, however, in formulating and updating a view on each fund sector as a whole.
Toogood said: 'Our research is driven by qualitative investment research which is informed by statistical analysis. When you are sifting down to any subsector the first thing is to understand who have been the major players in the past and who the new entrants are.'
That involves the use of past performance, however the quarterly fund review process, compared to an annual review timetable from S&P, is based on ongoing dialogue with managers.
Team members like Toogood, Cheeseman, Harris and Romer-Lee do not have a questionnaire approach to these interviews, but attempt to bring their experience and knowledge when rating funds.
In other words, for an intermediary to accept the value of the group's research it has to be convinced of the quality of the individuals formulating the recommendations.
Forsyth-OBSR divides up the onshore funds universe in a number of ways.
Funds are put into sub-groups depending on market cap, value, growth or blend investment style and geography. Toogood said this means the funds are compared with true peers and value funds do not get compared to growth funds.
Key to this, Forsyth-OBSR said, is a limitation on the number of funds covered. Forsyth-OBSR rate around 230 funds, a number that will not grow significantly, it said.
Forsyth-OBSR sees this as being more user friendly in terms of not overloading intermediaries with too much choice. S&P see it as a failing, limiting the choice of any brokers that use the service.
Advisers comparing the funds that the two groups rate will also see a great deal of difference. Forsyth-OBSR has 93 A-rated funds, 93 AA-rated funds and just 30 AAA-rated funds. S&P rates 1,200 funds in the combined onshore and offshore markets but does not segregate the different ratings.
Key AAA-ratings for OBSR are Investec's European fund managed by Albert Morrillo, Framlington Health, managed by Anthony Milford, both unrated by S&P, and Fidelity American, rated A by S&P.
For the new service visit www.forsyth-obsr.com. For S&P, visit www.funds-sp.com.
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