The hot or not fund lists

Published by David Prosser on 15 July 2014.
Last updated on 17 July 2014

Arrows in every direction

Retailers call it the 'paradox of choice' - it's the idea that while shoppers say with too much of it; give them too many options and they're overwhelmed by the difficulty of choosing between them.

It's a phenomenon that's familiar to the investment management industry. Investors looking for professional management, investment expertise and diversification now have access to thousands of collective funds - but how on earth do they pick the right ones?

Fund platforms claim to have the answer. While these online investment supermarkets do not offer financial advice, many publish lists of funds they rate particularly highly in each sector, or even offer model portfolios for different types of investor.

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Fund lists

Hargreaves Lansdown has The Wealth 150 universe, for example, while Fidelity FundsNetwork has The Select List. At the platform run by Interactive Investor, the owner of Moneywise, the equivalent is The Ready-Made selection, while Charles Stanley operates the Foundation FundList. Most platforms have a variation on the theme.

At first sight, it's a valuable service for investors – especially those who lack the time or expertise to trawl through hundreds of brochures to find the best funds.

Tread carefully, however. For one thing, these recommendations are no substitute for independent financial advice – they don't tell you whether a particular fund is right for you.

And second, the recommendations are only as good as the people at the platform making them – they're not infallible and, worse, the platforms have often had to defend themselves against accusations that their motives for picking particular funds are not always aligned with investors' best interests.

In short, the suggestion has been that certain platforms have sometimes recommended funds because they've been paid to do so.

Platform providers themselves recognise this is an issue that has to be confronted. Nick Curry, a director at one of the newer fund platforms, rPlan, says the sector has to be conscious of public perceptions, even if they're unfair.

When rPlan launched in 2011, it engaged an independent investment analyst to select its fund recommendations precisely because of this issue.

"We were worried many of the existing lists were seen as tainted by kickbacks and preferential rates of commission being paid by the fund manager to the provider if one of their funds was included on the list," Curry says. "There were suspicions and sometimes accusations within the industry that some providers didn't base their lists of top funds on merit alone."

Other platforms have tried similar tactics. Interactive Investor's Ready-Made portfolios, for example, are chosen by the team at Money Observer magazine, Moneywise's sister title, which operates independently of the platform, though Interactive Investor also has its own fund picks.

City regulators have also taken an interest in this issue: as part of the Retail Distribution Review (RDR), they have implemented reforms to address claims that platforms weren't honest and transparent.

Since April this year, the regime has covered all fund platforms: RDR requires platforms to itemise their charging structures so that investors can see what fees they're paying the platform itself and what fees they're paying to the fund manager.

Previously, the platforms typically charged a single annual management charge (AMC) for each fund an investor bought and then negotiated with the fund manager over how much they got to pocket themselves.

The fact the share prices of leading fund supermarkets plummeted when the new rules were announced is an indication that investors in these businesses at least were far from convinced the platforms were resisting the temptation to recommend funds from managers prepared to pay them more.

That said, there is no evidence of wrongdoing. And Mark Dampier, head of research at Hargreaves Lansdown, one of the UK's biggest fund platforms, rejects the suspicions as insulting and illogical – platforms weren't taking kickbacks before RDR, he insists, and they're certainly not doing so now.

"The suggestion managers could buy themselves on to a list is nonsense," Dampier says.

"For one thing, the financial services industry is so highly regulated that the idea we could get away with taking backhanders is ridiculous but, anyway, to do so would be utterly short-sighted – the last thing I need is angry clients who no longer trust me because we've rated funds highly for the wrong reasons and performance has then been hopeless."

So will RDR finally mean Dampier no longer has to answer these sort of questions? Fund platforms now sell funds as 'clean' – where no commission is payable to the platform – or even 'super-clean' – where the platform has negotiated a cheaper annual management fee for its customers. Surely, this environment guarantees integrity?

Not necessarily, says Justin Modray, founder of Candid Money, an independent financial analyst that specialises in comparing fund platforms.

For one thing, he points to a wrinkle in RDR – fund managers are still allowed to pay platforms to advertise on them. Even though the rules specifically prohibit any link between such payments and inclusion on a best-buy list, Modray says: "I would be wary of any lists unless a firm confirms they receive no such payments."

Competing on price

Moreover, Modray argues, while fund managers can't pay to get on to the recommended lists, the platforms compete with one another on the basis of price – it may therefore be in their interests to pick those funds prepared to offer their investors the cheapest AMC.

"Hargreaves Lansdown has said discounted annual fund charges are an influencing factor on determining the funds appearing in its Wealth 150 list," Modray says. "Since Hargreaves has an incentive to offer savings to help offset its own rather steep platform fees, there is a risk that price could have an undue influence on the funds recommended."

Mark Dampier insists the only reason price is a relevant factor in Hargreaves Lansdown's selection process is that he thinks expensive charges are to investors' detriment.

Another problem, concedes Ben Yearsley, head of investment research at Charles Stanley Direct, is that some fund recommendations are bound to perform better than others – and there will always be disappointed investors who take a cynical view.

"All the funds included [on our lists] are clean priced with no commission payable so you can be assured they have been chosen on merit, rather than for any commercial reason," Yearsley says.

"[But] investing is not a science – there is no right or wrong and it is only with hindsight that you can decide whether an investment was good or bad compared with its peers."

So where does that leave investors? Modray's advice is to compare and contrast. "On balance, recommended fund lists can be useful for investors if they take a straw poll across several firms," he suggests. "If the same fund appears on several lists, there's a fair chance the manager is well thought of and the fund might be worth holding."

Also, while price is routinely the determining factor on which investors choose a platform - and all the platforms have fought hard to position themselves as good value since RDR forced them to restructure charges – this shouldn't be the only issue. Investors who intend to follow a platform's recommendations should spend some time looking at how they are generated.

Broadly speaking, these rely on a two-stage screening process. Most platforms use a quantitative analysis that generates a shortlist of funds potentially worth recommending on the basis of whatever criteria they deem suitable – typically related to performance relative to market benchmarks.

Then there is a qualitative element, where the platform interviews the managers of the shortlisted funds before making a final decision about whether to recommend them.


Jason Hollands, managing director of BestInvest, explains: "Our starting point is the current fund manager's career track record across firms and similar mandates they have managed in the past.

Our goal is to differentiate between luck and judgement, so past performance needs to be scrutinised over multiple time periods, and performance attribution analysis can help indicate whether stock selection has added value or whether the return is primarily down to the positioning of the fund."

Most platforms publish details of their processes on their platforms and it is worth scrutinising several sites in order to get a feel for what is robust and comprehensive. Also look into how often recommended lists are reviewed – and what the criteria are for dropping funds.

Ultimately, if you're not convinced by the methodology the platform sets out for making its recommendations, don't follow them, even if it has the edge on price. Sometimes, the platforms offer past performance statistics on their selections, which may be a useful indicator of how well their recommendations have done, at least until now.

Above all, remember that platforms aren't advisers – they make their recommendations without any knowledge at all about what individual investors are hoping to achieve. You'll need to consider your attitude to risk, your time horizons and your existing savings and investments, for example, in order to decide which fund recommendations on a platform, if any, suit you best.

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