The role of research houses in Australia’s investment ecosystem has come under renewed scrutiny following the collapses of the Shield and First Guardian Master Funds, with FundMonitors.com chief executive Chris Gosselin warning that the system is “potentially highly conflicted” and in need of reform.
Gosselin said research reports and ratings represent the first link in the distribution chain for fund managers seeking to raise money through advisers and platforms.
“In the case of Shield and First Guardian, it is clear that no rating should have been issued,” he said.
He warned that the research process is “potentially highly conflicted” as the fund manager pays the research house for the report.
According to Gosselin, fund managers are not so much paying for a report as they are “paying for the rating”, which becomes the crucial step to accessing licensees’ approved product lists (APL) and distribution platforms.
“This is because advisers, or more correctly their dealer group or licensee, insist on a fund having an acceptable research rating before they’ll add it to their APL,” he said. “Even though the rating itself is essentially only a rubber stamp, there’s the potential that the report is not read fully or properly evaluated.”
Fund managers typically pay around $35,000 per year per fund for a single research report and many pay for multiple reports to ensure coverage, according to Gosselin.
“For a fund manager with multiple funds, the total cost is significant, in some cases well over $500,000 a year, without which their fund inflows don’t occur, slow significantly – or worse, become outflows,” he said.
Moreover, he argued that while many research houses manage conflicts appropriately, the Shield and First Guardian cases highlight potential issues in a system where “a research report should be unbiased” but is paid for by the subject it evaluates.
Gosselin said reform must focus on two key areas: oversight and payment structure.
“At the moment, there is very little regulatory oversight to ensure the accuracy and independence of fund research.”
Although research houses should hold an Australian Financial Services Licence, Gosselin said ASIC’s approach has been “relatively light touch” because research reports are distributed to advisers rather than investors and technically do not contain advice.
He also called for a new payment model: “Rather than the fund manager paying for the research, the platform or end user should pay. A beneficiary pays approach would remove the conflict inherent in the system.”
However, he cautioned that change is unlikely soon, as the system is “too entrenched”.
“…and even though over the years there have been regular occurrences of unscrupulous or dishonest fund managers defrauding investors armed with glowing or positive research reports, Shield and First Guardian are merely the latest iteration,” he said.
“Unless the system is changed it is unlikely they’ll be the last.”
Gosselin said research should deliver thorough due diligence on a fund’s operations and management, including strategy, compliance, conflicts, and third-party relationships, alongside robust analysis of past performance and risk, areas he noted often diverge from positive research ratings.
To strengthen transparency, Australian Fund Monitors has developed a Quantitative Peer Group Ranking Star ratings system that tracks performance and risk over one, three, five and seven years across peer groups.
“They’re a high-level indication only,” Gosselin said, noting multiple underlying quantitative metrics.
Furthermore, he urged advisers and platforms to assess research more critically.
“Does the research clearly outline who the manager is, what they invest in, how they invest, and what the risks are? Does it show past performance and risk including the potential for loss of capital?
“Let the numbers do the talking,” Gosselin said. “ASIC correctly cautions that historical performance is no guarantee in the future, but in-depth analysis of past performance and risk metrics provides a more accurate indication than all the words in a research report.”
