Question
I use several discount brokers' websites and rating websites to give me ratings for funds. (Morningstar, Citywire, Lipper, Hargreaves, Bestinvest, Close, etc.). I understand that backhanders/overriders/secret commissions are given to some brokers to promote certain funds or fund providers. Are you able to confirm this, and which do receive these? Is the RDR going to prohibit this practice, or compel the transparency of this practice?
How can I know whether highly rated/Best buy funds are the result of these incentive-based payments?Answer
An interesting question, thank you. I'll do my best to cover your concerns, but as things stand there's still insufficient transparency to give a definitive answer. So I don't get sued, let's define backhanders/overriders and 'secret' commissions as an amount of money received that isn't explicitly disclosed to the public.
Let's start with Morningstar, Lipper and Trustnet. These companies make the majority of their revenue from selling investment data, usually costing thousands of pounds a year. Their target market is financial services companies and websites, although Morningstar and Trustnet offer free consumer websites with limited data available. Given their ratings appear to be based solely on quantitative analysis, i.e. performance, there's little scope for bias - even if they subsequently charge fund managers to use the ratings for marketing purposes.
Citywire is a well-regarded financial publisher, that generates a fair amount of its revenue from charging fund managers for advertising, displaying ratings and events etc. So, on the surface, some cause for concern that this could lead to bias. It publishes two ratings: Citywire Selection and Citywire Fund Manager Ratings. The latter is entirely stats driven, so no scope for bias. Citywire Selection involves human judgement in the ratings process, so in theory this could be influenced by commercial pressures. Citywire says no on its website and I believe them - but no way of knowing 100% for sure
Hargreaves Lansdown and Bestinvest both publish research, primarily to support their main business of selling funds. They also both operate their own fund platforms ('Vantage' and 'Select' respectively).
As both are execution-only services they're allowed to continue receiving sales commission, which must obviously be disclosed. I've never bothered to check whether there's a correlation between levels of commission paid and the ratings given by each firm, but I very much doubt it - commissions are largely standardised in any case.
More of a grey area is the platform fees received by each company from fund managers, as neither company currently discloses these. They come out of annual fund charges, so not an extra fee, but they could obviously give potential for research/marketing bias if some fund managers pay higher fees than others. As the amounts aren't disclosed, it's impossible to get a clearer idea of whether this might be an issue.
Both the above should cease to be potential issues in due course. The FSA plans for fund platform fees to be paid customers and not fund managers by the end of this year. And a ban on execution-only sales commissions also looks likely within the next couple of years.
More generally, I think fund managers often contribute towards costs when brokers/advisers send marketing mailings featuring that manager's fund(s). Payments should only cover the actual cost of printing/postage etc, hence not a way to profit, but I suppose a manager who's reluctant to pay reduces the chances of their fund's inclusion, no matter how good it is. Again, there's no transparency here, it would be nice if the FSA compelled companies to disclose this information where applicable.
Adviser/broker research analysts often attend lunches and the occasional working trip abroad, typically paid for by fund managers. Again, it would be nice to see recipient companies either disclosing such hospitality or outright refusing it, but as the practice is so widespread I think the risk of this influencing research is minimal - it certainly didn't seem to influence Bestinvest's research during my time there (2003-2007) - the analysts were very focussed on selecting funds that would be best for clients.
In summary my gut feeling is that undisclosed payments probably have, on occasion, affected the research published at some companies (which ones? I don't know). But, even if true, I suspect this is probably at the margin - for example giving preference to one of two good funds, rather than slapping a decent rating on a poor fund. Nevertheless, it would be nice if the world was more transparent (including financial services), but I guess that's life...
I use several discount brokers' websites and rating websites to give me ratings for funds. (Morningstar, Citywire, Lipper, Hargreaves, Bestinvest, Close, etc.). I understand that backhanders/overriders/secret commissions are given to some brokers to promote certain funds or fund providers. Are you able to confirm this, and which do receive these? Is the RDR going to prohibit this practice, or compel the transparency of this practice?
How can I know whether highly rated/Best buy funds are the result of these incentive-based payments?Answer
An interesting question, thank you. I'll do my best to cover your concerns, but as things stand there's still insufficient transparency to give a definitive answer. So I don't get sued, let's define backhanders/overriders and 'secret' commissions as an amount of money received that isn't explicitly disclosed to the public.
Let's start with Morningstar, Lipper and Trustnet. These companies make the majority of their revenue from selling investment data, usually costing thousands of pounds a year. Their target market is financial services companies and websites, although Morningstar and Trustnet offer free consumer websites with limited data available. Given their ratings appear to be based solely on quantitative analysis, i.e. performance, there's little scope for bias - even if they subsequently charge fund managers to use the ratings for marketing purposes.
Citywire is a well-regarded financial publisher, that generates a fair amount of its revenue from charging fund managers for advertising, displaying ratings and events etc. So, on the surface, some cause for concern that this could lead to bias. It publishes two ratings: Citywire Selection and Citywire Fund Manager Ratings. The latter is entirely stats driven, so no scope for bias. Citywire Selection involves human judgement in the ratings process, so in theory this could be influenced by commercial pressures. Citywire says no on its website and I believe them - but no way of knowing 100% for sure
Hargreaves Lansdown and Bestinvest both publish research, primarily to support their main business of selling funds. They also both operate their own fund platforms ('Vantage' and 'Select' respectively).
As both are execution-only services they're allowed to continue receiving sales commission, which must obviously be disclosed. I've never bothered to check whether there's a correlation between levels of commission paid and the ratings given by each firm, but I very much doubt it - commissions are largely standardised in any case.
More of a grey area is the platform fees received by each company from fund managers, as neither company currently discloses these. They come out of annual fund charges, so not an extra fee, but they could obviously give potential for research/marketing bias if some fund managers pay higher fees than others. As the amounts aren't disclosed, it's impossible to get a clearer idea of whether this might be an issue.
Both the above should cease to be potential issues in due course. The FSA plans for fund platform fees to be paid customers and not fund managers by the end of this year. And a ban on execution-only sales commissions also looks likely within the next couple of years.
More generally, I think fund managers often contribute towards costs when brokers/advisers send marketing mailings featuring that manager's fund(s). Payments should only cover the actual cost of printing/postage etc, hence not a way to profit, but I suppose a manager who's reluctant to pay reduces the chances of their fund's inclusion, no matter how good it is. Again, there's no transparency here, it would be nice if the FSA compelled companies to disclose this information where applicable.
Adviser/broker research analysts often attend lunches and the occasional working trip abroad, typically paid for by fund managers. Again, it would be nice to see recipient companies either disclosing such hospitality or outright refusing it, but as the practice is so widespread I think the risk of this influencing research is minimal - it certainly didn't seem to influence Bestinvest's research during my time there (2003-2007) - the analysts were very focussed on selecting funds that would be best for clients.
In summary my gut feeling is that undisclosed payments probably have, on occasion, affected the research published at some companies (which ones? I don't know). But, even if true, I suspect this is probably at the margin - for example giving preference to one of two good funds, rather than slapping a decent rating on a poor fund. Nevertheless, it would be nice if the world was more transparent (including financial services), but I guess that's life...
Read this Q and A at http://www.candidmoney.com/askjustin/787/do-backhanders-compromise-fund-research
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