Stars and Strife- 27th November 2002
John Collett - Sydney Morning Herald
Stars and strife
John Collett | November 27 2002 | Sydney Morning Herald
Funds researchers are locked into a battle, the outcome of which could affect how Australians invest for years to come.
In the blue corner is the US heavyweight funds researcher Morningstar. In the red corner is the home-grown contender, van Eyk Research. In the US, Morningstar's views on managers and funds can determine which funds thrive and which don't but it's a different story down under.
The local turf is dominated by high-profile researcher Stephen van Eyk, who has built a research house whose managed funds research is used by 65 per cent of financial planners.
Industry observers say that the Australian financial advisory market cannot sustain the two main researchers, van Eyk Research and Morningstar, let alone the two smaller research houses, InvestorWeb and the St George Bank-owned Assirt. Then there is the global consultancy company William M Mercer, which advises many of the big superannuation funds. In March this year Mercer tried to buy van Eyk Research.
For investors, the outcome will matter because the two major contenders rate funds in starkly different ways.
Fund managers' investment processes are becoming more complex and there's an explosion of funds investing in niche areas such as ethical and hedge funds.
Investors and their financial advisers haven't the skill nor time to assess managers' performance and skills. There's also the difficult question of how funds should be blended together in an investment portfolio.
Research house van Eyk's approach to portfolio building is through its "model portfolios'' a range of preset blends are offered to reflect the investment objectives and risk tolerance of the investor.
Which funds are used in the blends is the result of van Eyk's qualitative research, which consists of an assessment of the manager's investment philosophy and process, and the quality of the managers' investment staff. Little attention is given to performance.
"To my mind, a forward-looking view makes sense; it is crucial,'' says Dominic McCormick, chief investment officer of Select Asset Management.
"A backward-looking research that overemphasises historical performance can actually lead to investors chasing past returns,'' he says.
McCormick thinks it is no coincidence that chasing past performance is most apparent in the US, where star ratings are solely based on investment history. "Past performance is not a sound basis on which to base investment decisions,'' he says.
In the US, funds are rated on past performance because regulators do not allow subjective forward-looking research to be used in ratings. Morningstar in the US publishes its qualitative research as commentaries separate to its ratings.
In Australia, largely because of the pioneering work of van Eyk Research, advisers have an appetite for forward-looking research of managers and their funds. Indeed, van Eyk awards its highest ratings "AA'' and "A'' to a fund based almost entirely on the qualitative aspects of the fund.
Morningstar has recently moved to more closely align the way it rates funds in Australia with the way it rates them in Europe and the US. It has simplified its star ratings. As before, half the rating will be based on past performance and half on forward-looking research, but the forward-looking component will be reduced from five categories to two.
The five old categories investment management, corporate strength, administration and distribution, sector strength and product features have been replaced by sector strength and business, and management strength.
Morningstar has moved from doing a top-down review of a manager, rating all of the manager's funds at once, to rating investments sector by sector. For example, Australian shares funds will be rated at the same time to overcome the problem of funds being rated at different periods of the investment cycle.
The managing director of Morningstar's US parent, Don Phillips, says its Australian research house is committed to maintaining the qualitative component of its star ratings.
Phillips, in Sydney last week to address a financial planning conference, dismisses out of hand any suggestion that the simplification of its ratings process has anything to do with cost cutting. He says it is about delivering a better ratings process.
"Slicing and dicing past performance only gets you so far,'' he says. "The key is going in and doing the qualitative work and checking on the managers.''
However, Morningstar's plans to use the new process to roll out the ratings have suffered a setback with the sudden departure of its head of research, Daisy Chee.
Phillips says Morningstar Australia will be appointing a new head of research but concedes, with Christmas not far off, the position is not likely to be filled until next year.
Meanwhile the task facing researchers is only getting bigger. Van Eyk says his company is in the midst of its review of Australian managers and that it's including twice the number of managers as it did when doing the report five years ago.
"There are hedge funds and private equity funds, areas that we just did not have to cover five years ago,'' says van Eyk. "Managers' investment processes have also become more complex and you really need experienced staff. It's a big task to say, `These are the managers who are going to earn you the most money over the next couple of years'.''
Advisers will decide which research houses and processes survive as they place more than 90c of every dollar of retail investors' money going into managed funds.
Peter Thornhill, the principal of Motivated Money, says what is really needed is someone to research the researchers. "We don't really know how much success each of the researchers is having relative to each other in predicting the future performance of funds,'' he says.
He suspects than many financial advisers and their dealer groups are signing up for research without really studying the differences in the way they rate funds. He says advisers treat the research as an insurance policy so that if something goes wrong they can point the finger at the research house.
Thornhill says research houses deny their ratings have any predictive power on funds' future returns or are at least equivocal on the point but investors certainly think they do.
But Thornhill says that investors should not expect too much from researchers. He says their task is more daunting than ever, with the unprecedented change in ownership of fund-management businesses and the number of portfolio managers departing.