With the proliferation of advertising and promotion, and the internet, separating the wheat from the chaff when selecting funds and products is paramount.
We are all now pretty familiar with the media reporting downgrading of global economies or, more refreshingly, highlighting a positive trend with an upgrade, but what function do these “ratings” agencies fulfil? The key players on the macro level are Standard & Poor’s, Moody’s and Fitch, and what they do is, in simple terms, apply a marking or grading system to the financial health and creditworthiness of a government or corporation. On the basis of this, interested parties can make an assessment of the potential “risk” of lending to the organisation being rated, including the thorny question about the potential for default.
“The reasons for ratings adjustments vary and may be broadly related to overall shifts in the economy or business environment. Or they may be narrowly focused on circumstances affecting a specific industry, entity or individual debt issue”.
As a broad yardstick, the output from global ratings agencies does have considerable influence on day-to-day economics and markets, notwithstanding the sudden impact politicians and policy-makers can have on this.
Scaling things down to the world of investment funds and the many fund houses and providers, the complex issue of “ratings” is a minefield for advisers and clients to make any sense of. It is essential to bear in mind that credit risk rating agency output is not the same thing as the risk rating that agencies apply to investment funds.
When considering funds to include in a portfolio, the adviser needs to be very clear on the value the leading ratings providers can add to the decision-making process when selecting funds for a portfolio. Examples of the leading players are Morningstar OBSR, Citywire, FE Crown and Trustnet Alpha managers.
Ratings agencies function within the financial services business by delivering “independent” ratings on investment funds and fund management teams. This information is intended to provide potential investors with guidance and data on exactly which funds and managers are performing well.
The most important issue is that advisers follow a robust and demonstrable and comprehensible investment process. This may or may not rely upon input from ratings organisations to provide third-party objectivity and quality measure to overlay on the quantitative data.
Good research and fund selection should only use ratings to provide a measure of quality of funds being considered, not the other way round; just because a fund or fund provider has “ratings” or stars does not mean the fund is a “shoe-in” for any portfolio. All ratings do is steer the IFA’s thought process and help him to reach a well-researched fund selection outcome.
The key areas of risk that advisers and their clients must take on board during the decision-making process on fund selection and asset class are:
