Is fund selectors’ research up to scratch?

Fund selectors are set to face tougher scrutiny as calls grow for greater transparency on how they do research, experts have said.

Greater focus has been put on fund researchers over the way they can influence investors’ decisions as some have lobbied the FCA to bring fund ratings agencies under the regulator’s watch.

Speaking at the Thomson Reuters Lipper European Fund Selectors Forum yesterday, Rathbone Brothers head of collective investments Mona Shah said the focus on transparency is making the life of a fund selector harder.

She says: “I welcome the scrutiny on fees but cheaper is not better, it is about value”.

Citywire head of cross border investment research Nisha Long added: “Fund selectors are coming under more scrutiny. We’ll always prefer in-house research rather than outsourcing it. We look at those gems to be found in boutique firms.”

So what makes “a good fund”?

In its final report into the asset management industry, the FCA said some respondents wanted the fund ratings industry to be regulated to ensure it operated fairly for investors.

Fears mainly revolve around the business models of research firms where “conflicts” such as fund managers paying to be included in “best buy” lists are seen to distort the value of ratings.

Research firm Square Mile measures fund performance twice a year and head of research Victoria Hasler claims three quarters of the funds the firm rates are exceeding their objectives.

Speaking at the conference, Hasler said: “At Square Mile we only deal with IFAs or wholesale clients, that is why we are not regulated but we would welcome regulation.”

Shah added: “For any buy list, you don’t want all the funds to outperform all the time because that means you don’t have a good fund range [in your section].

“We make sure the funds on our lists are fit for purpose. If you see they have a low turnover [figure] is a good one. We don’t look at external funds ratings.”

Experts said the typical screening process risked leaving some good funds behind.

Hasler said: “We make sure the fund is doing what it says it is going to do. If a fund is too small you screen it out as [in that case] it is difficult for managers to diversify. On a performance basis if the fund is constantly losing money you put it aside. But sometimes you might miss good funds from the screening.”

Shah argues screening funds by size is “dangerous” as they might be able to grow quickly or close down quickly too.

This week, gbi2 managing director Graham Bentley said the importance of research in fund selection is “undeniable”, but had found “significant differences” in the quality of some research practices.

He says: “Tight budgets mean managers need to know which researchers to engage with and who to ignore. We see funds that are not on the lists that should be.”

Platforms’ stake in the game

The FCA will assess to what extent platforms are dependent on third party fund rating firms as well any issues impeding transparent flow of information for consumers as part of its upcoming investment platforms market study.

Fund selectors argued there is “too much commonality” among platforms in their choice of funds without looking at other potential candidates.

Long said by focusing on a certain fixed offering of funds consumers can miss out on good boutique names, arguing that most of the time it is these boutique fund managers that perform the best.

However, Lipper found big asset management players have dominated European fund flows in 2017 over boutique asset managers, compared to 2016 were the picture was more mixed between larger and smaller groups.

Promoting passives

In its asset management study, the FCA also points out at the lack of negative fund ratings as evidence that ratings can be biased and that fund lists don’t promote enough passive funds.

Halser attributes this to the inability of most platforms to split shares of ETFs on their systems, a practice called fractional dealing and currently only offered by Nutmeg, Winterflood Business Services and Novia Financial’s discretionary service Copia.

Shah said: “The key point for passives is that they can give you access to a specific opportunity [in the market]. Due diligence can be larger on passives than mutual funds, especially on stock lending.

“It is important to keep good level of disclosure on passives as well for them to compete against active funds.”