Just at the point when Europe’s investors are familiarising themselves with the mutual fund ratings game, the industry takes another turn.
Moody’s Investor Services, synonymous for its credit quality ratings on bond and money market funds, is turning its attention to the equity fund market. While this will come as little surprise to those who have wondered why the fund ratings industry in Europe is dominated by so few, the addition of such a force in the market is not necessarily a positive one.
The growth of the European funds market has undeniably been fuelled by the explosion in the number of equity products, and whilst its key rival, Standard & Poor’s has been making a name for itself in rating this market with the purchase of Fund Research, Moody’s focus has been elsewhere. But that is all about to change. Moody’s will soon be launching a product into the European market and is taking its own individual approach as to how Europe’s mutual funds will be judged in the future.
Moody’s Fund Analyzer, which will be available in Europe at the end of the summer, will rate equity funds based on the one factor Moody’s believes will become increasingly important to European institutional investors over the next few years – style consistency. David Vriesenga, director global fund ratings at Moody’s in London ex-plains: “Typically when you analyse the performance of a fund it gets classified as far as it is a Euro growth fund or it is a Euro value fund, that type of general classification. However in many cases these funds are not managed in a way that is consistent with that classification because there are no legal requirements for them to do that.” In other words, these fund managers are not doing what they are supposed to. Aside from the asset allocation implications this could have on a pension fund’s overall portfolio, the key issue here, says Vrie-senga, is that a fund may under or ov-erperform an index, but the question is whether that was the correct index to be measured against in the first place. If not, then the rest of the pro-cess is flawed, so the argument goes.
Moody’s will be taking a weekly feed of performance data for funds which are distributed in the UK, France and Germany initially with other countries to follow soon after, and the product will cluster the funds into how they are performing in real terms as opposed to how they do compared with so-called peer funds claiming to share the same style umbrella. “It takes a fund and it can go in and tell you whether actually it is a high tech fund or actually a tech fund, or what kind of sector it is in, whether it is more aggressive growth than pure growth,” he says. Moody’s estimates that it will use around 23 different classifications for this process and over time it says the product will give transparency of the fund manager’s trades to levels of around 90%. “When a fund manager makes a strategic change in its portfolio, you can see within a month where it is moving.”
Moody’s belated entrance into the equity fund ratings game will highlight the lack in consistent approach taken by fund managers, but its own take on the market also reveals the gross disparities in opinions amongst the ratings agencies themselves. The industry as it stands is largely divided between two groups: the number crunchers, Micropal and Lipper, boxed into the fund ranking category, but who have both in the past year introduced their own rating systems in the form of Micropal Stars and Lipper ARCs; and the mainly qualitative fund rating agencies being S&P Fund Re-search and Forsyth Partners hailing from the UK with smaller firms, including FERI Trust in Germany, Lipper-owned Bopp Fund Services and RCP Partners in Switzerland and newcomers AMR in France and Blue Rating in Italy bringing up the rear. Moody’s, incidentally, will be taking a quantitative perspective. “Most of it will be quant driven. Strategy is not going to matter because within a month we are going to know what strategy they are using anyway,” says Vriesenga.
Moody’s main competitor, S&P Fund Research is also planning to expand into Europe, and will have a presence by the end of the year in France, Germany and Switzerland to analyse cross border funds. Following that it will be recruiting talent in the Netherlands, Spain, Italy and Scandinavia. The competition that already exists in those markets do not seem to be of much concern to S&P. “I don't really call somebody doing a factsheet and giving a rating without interviews competition,” says Nigel Slade at S&P Fund Research in London. “I call it a product.”
And this is where the cracks begin to show. Each provider has its own opinion on what is the best way to judge a fund. An example: “You shouldn't rely on the quants,” says Paul Forsyth at Forsyth Partners in Croydon. “You should go out and talk to the fund managers and find out what they are doing.” Forsyth’s universe of 150 funds is analysed on a long only basis and a top tier rating - a triple A - does not necessarily mean that it is the most successful fund. Conversely, it is in this field that gross underperformer Gartmore has maintained its dignity - three out of the four Gartmore funds analysed by Forsyth carry triple A ratings, the top score, signalling the firm's confidence that the fund manager will bounce back over the long term. “We are not going to upgrade and downgrade every quarter. That would be meaningless.”
Lipper's ARC medals system is purely quant driven, as is Micro-pal's Star ratings. “We make no qualititative judgements at all. It is based on the consistency of performance against a variety of different calculations,” says Diana Mack-ay at Lipper. “Basically you are looking at the ability of a fund manager to produce a performance that is consistent with some kind of an independent benchmark.” That benchmark is established by Lipper, as op-posed to any sector average, which means drawing any comparisons between funds rated by Micropal against Lipper is relatively pointless.
The arrival of AMR in Paris, a ratings service launched last summer by ex-Finance et Arbitrage consultant Antoine Briant, will not make matters any easier. Following in the path of Swiss firm RCP Partners which provides fiduciary rating and performance services of fund management companies in Europe and Asia, AMR has opted for rating the provider itself as opposed to the fund in the belief that focusing on the product itself is too “impartial”. AMR rates the fund managers themselves based on a set of quantitative and qualitative criteria and says this set of data can guide investors on choosing asset managers whether they go the segregated route or the fund route - the medium used to invest shouldn't make any difference to the processes and structure of the management house.
With such a wide spread of ap-proaches, it is no surprise that the conclusion as to what makes a good buy and what does not can drastically differ from agency to agency. Looking at S&P Fund Research, unlike with bond or money market funds, their equity fund ratings do not convey the levels of risk or volatility as investors have different risk tolerances for equity investing. In this sense a highly aggressive fund is just as likely to carry a triple A rating as a conservative fund, as long as S&P’s own criteria are met. “Volatility means different things to different people,” says Slade at S&P. “We have such a wide spectrum of users all looking for different things so our job is to make sure they are armed with the facts so they can make their own judgement.” But compare S&P’s ratings with say, Forsyth’s, at your peril. If you were interested in buying the GAM Japan fund, you would find both agencies agree on its worthiness by awarding it with a triple A rating. If you opted for the GAM GAMCO fund however, Forsyth gives it a triple A, whereas S&P’s opinion is much lower – the other end of the scale in fact in the single A category. The decision is yours.
The ratings scale for Moody’s product is unlikely to take the A-AAA route as Moody’s feels it would be too confusing vis a vis its own bond and money market rating service. “There is an issue of investors being confused that they have this bond fund rated triple A, they have an equity fund rated triple A and the risks between the two are very, very different. And that is one thing that we are grappling with internally.”
But Moody’s decision over whether it uses a numerical or alphabetical scale is purely a cosmetic one and does not ease the differences that exist which are potentially confusing for the investor. The fact that Moody’s is proud that it will not be approaching the market the same way as its competitors is a problem in itself. If investors cannot compare Lipper’s opinion alongside Micropal’s to make a balanced judgement, and equally take on board S&P’s commentary with that of Moody’s, then the rating process be-comes contrived and individualistic. In the absence of a consensus of opinion on fund ratings, then that is really all it is - an individual firm's opinion. As such, mirroring the world of the investment consultants, investors must first of all decide whose opinion they value most before the process of selecting a fund even begins.
And in this sense it is important to keep fund ratings in their proper perspective. The US market is good to look at in this instance, for how not to do it. Morningstar has been such a phenomenal success that 80-90% of DC assets are invested in the funds it rates. The only problem being is that investors have tended to buy those funds rated the highest, based on the absolute trust they have in the rating agency's judgement, and then selling them when they get downgraded. The opposite in fact of what they should be doing.