- Credit risk.
- Currency risk.
- Inflation risk.
- Taxation risk.
- Market risk.
While ratings agencies can provide some input on this, they do not cover all the bases.
In the new post-RDR world, do they make the fund selection process more transparent?
A major driver of the retail distribution review was to make things clearer and more transparent for potential clients to understand what was being proposed, and the costs and implications. As part of this change, fund costs and charges have undergone a root and branch change, and it should be beneficial for clients and their advisers.
For example, consider the current way ratings agencies assign a score or measure to bonds. Many people will or should be familiar with the terminology AAA, BBB, BB and C when attached to the marketing material promoting a particular investment proposition. The letters indicate a rating measure of “quality” as follows:
- AAA — Top for safety and risk.
- BBB — Relatively safe.
- BB down to C — Speculative or junk and risk of default.
So, as a crude rule of thumb, the adviser and/or their client can make judgements on the funds bearing the different gradings and the risk inherent in making an investment.
Where investments are not bonds in nature, different ratings agencies will attach a variety of rankings and labels, and it is down to the adviser to evaluate what they mean and their use in the fund selection process.
One well-known ratings provider regularly reviews, comments on and ranks individual fund managers in terms of their risk-adjusted performance over different time frames, awarding AAA or AA or A ratings to those individuals and investment teams who meet or exceed pretty demanding performance criteria. Advisers can use this information as part of their due diligence on risk, but it is only one piece of the jigsaw.
Another mainstream provider of ratings publishes its analysts’ views on individual funds and how well it believes they will perform in relation to their benchmark. It will also consider the risk inherent in their investment strategy over five- and seven-year economic cycles. There will be an emphasis on:
- The fund manager or team.
- Delivery and consistency of investment process.
- Adherence to the stated investment strategy and how it translates into returns for investors.
- Charging structure and the offer of fair value.
- Financial strength of the investment house.
- Outcome of the careful analysis of these criteria results in a fund being given a Gold, Silver or Bronze rating.
This does create problems for advisers when it comes to differentiating between these ratings, deciding which ones to rely on and how to communicate this to investment clients.
In 2010, the Committee for European Securities Regulators produced some important consultation documents around the proposed introduction of Key Information Documents (KIIDS) to provide clear concise information on Ucits funds.
