Which ratings house models do advisers trust?

Who do financial advisers trust more? Research and ratings houses which charge fund managers up-front to rate their funds, or research and ratings houses which cover their costs indirectly through consulting or other means?

An analysis of the Australian funds management ratings house sector to be published later this month has confirmed that the commercial models of the ratings houses and the impact of those models on perceived objectivity continues to be an issue.

The analysis has also confirmed that while financial advisers continue to be the major source of retail funds management inflows, it is the platforms, ratings houses and other intermediaries who are clipping the ticket for as much as 40% of the annual management fees charged to investors.

It confirmed an Australian Securities and Investments Commission analysis that the actual fund management fee charged by fund managers tends to represent about half of the total fee paid by investors.

Investors typically pay a:

• Fund management fee: 70 to 100bps – The fund management fee is discussed in detail in Section 4.3. – Typically, the fund management fee as presented in PDSs covers the internal costs of investment management as well as third-party costs, which includes the cost of acquiring ratings from research houses.
• Platform fee: 15 to 30bps – This administration fee covers the cost to the provider of running the platform. Evidence suggests that platform providers have been reducing fees to remain competitive.
• Advisory group fee: 60 to 100bps – This is typically a fee for ongoing advice but can also be a percentage-based fee based on the value of assets held.

The Financial Newswire analysis of the ratings house sector also examines the changes which have been wrought as a result of the exit of the major banks, and the manner in which some ratings houses have expanded their offerings beyond the core business of ratings and into managed accounts, model portfolios and even publishing.

The analysis confirms the findings of the Australian Securities and Investments Commission’s recent Report 702 which focused on the Australian funds management industry but which also noted the manner in which managed accounts had introduced asset consultants into the retail distribution mix.

The analysis confirms the number of ratings houses also consulting on managed accounts in competition with smaller asset consulting businesses.

When examining the scope for conflicts of interest with respect to ratings house commercial models, the ASIC report suggested that ratings houses which only rated a fund when the fund manager was willing to pay for the rating represented a “potential conflict of interest”.

“The supply-side business model employed by some research houses represents a potential conflict of interest, as they are remunerated by the fund managers they are rating,” the ASIC report said.

“This creates incentives to give positive ratings (and not give negative ratings), and it is not required that research houses publish negative ratings as well as positive ratings. The business model also allows fund managers to search for the research house that will provide them with the best rating, then pay for this rating and use it in their advertising material.”

The Financial Newswire analysis raises questions about whether the demand side and associated consultancy arrangements deployed by some ratings firms also create tensions and conflicts.