The FCA’s recent findings on the so-called asset consultants, a catch-all term that encompasses fund selectors, ratings agencies, and the like, has called greater attention to the notion of “value-add”.
Coupled with the fact that active managers have struggled to outperform their passive counterparts in the last five to six years of this seemingly never-ending bull market, the question “What value, if any, have fund selectors added to the end client?” seems even more relevant.
Though the FCA received a number of responses which strongly disagreed with its hypothesis that on average, investment consultants are unable to identify managers that outperform, there were a number of respondents who sided with the regulator.
In light of this additional scrutiny from the UK watchdog, the perhaps lesser known research and ratings firm, Fundhouse, boldly decided to publish its fund selection track record.
But Hargreaves Lansdown, the market’s biggest direct to consumer player, beat them to the punch by publishing the track record of the constituents of its Wealth 150 list, which at the time was touted by the firm as “the most transparent and comprehensive analysis of any preferred funds list ever published”.
Impressively, Hargreaves’ data stretched back all the way to the inception of its best-buy list in 2003, showing that on average, its top 150 funds returned 12% more than their Investment Association sector category, 13.5% more than comparative tracker funds and 6.5% above their relevant benchmark indices.
But one thing that Fundhouse did, which to my knowledge, has not been done before is to compile (and publicise) underperformance data on the funds it stamps with a negative rating.
The firm uses a tier-based ranking system, where Tier 1 represents the best rating and Tier 3, the worst. Thought of another way, the funds that are most likely to outperform on average versus the funds that are most likely to underperform.
To Fundhouse co-founder Rory Maguire, allowing investors the opportunity to see the funds they should avoid is the value add-proposition.
Of all the funds rated by Fundhouse, the group with the “strongest signal” is produced from the negatively rated Tier 3 funds, which the firm found underperformed 82% of the time.
In other words, by looking at Fundhouse’s track record, investors have statistically benefited the most by heeding the firm’s advice on funds to avoid.
Ex-Investment Association chief executive Daniel Godfrey believes that there is probably “no perfect solution” for fund selectors to adopt to be able to clearly articulate how they add value.
Not every firm has the capabilities and the resources to cover the entire universe of UK retail funds within its ratings like a Morningstar, says Godfrey.
But one thing he thinks all fund selectors can do that would benefit their clients is to pay more attention to time horizons.
“Another thing that comes to my mind when we talk about value added and value detracted is what time horizon are we looking at?
“Universally, we would say don’t invest in a fund unless you have a five-year time horizon, so it seems to me to be curious why some firms might rank or try to rate a performance over anything less than that period.”
Marrying the long-term behaviour and performance of a fund manager with the research process is something Godfrey thinks Hargreaves in particular has got right over the years.
Godfrey stresses that when it comes down to it “there are many different ways of adding value, but what I’m really looking for is people who I believe have the discipline to make you confident they can succeed in delivering on their mandate over a long time period”.
Dan Brocklebank, UK director at Orbis Investments, agrees with Godfrey that there are other ways of adding value to the fund selection process that seem to get left out of the equation because they are trickier to quantify.
“When it comes to fund selection, everyone gives you the standard information, the bit that’s easy to put into a template, but the things that really matter you can’t put into a template. You have to assess them qualitatively.”
If fund selectors really want to make life easier for their clients, Brocklebank suggests their ratings should address questions like: Does the fund manager invest alongside shareholders on the same terms? Is it a privately owned company? Or do they have external shareholders and are therefore more likely to be motivated by profit? What do their fee structures incentivise them to do?
“Incentives are so powerful in any industry, but very few people look at the role of the fee structure that is in place with the manager,” says Brocklebank.
While the investment consultancy industry is not without its faults, the consensus seems to be that that doesn’t detract from their ability to add value through good, quality research.
In fact, every person I spoke with mentioned how important it was for fund selectors to stand up and prove their worth to clients and the regulator.
“I think it’s good that people at Hargreaves and Fundhouse are beginning to address this point from the FCA and say, ‘no, there is value in what we do’ because I think good research does add value”, says Godfrey.
