Leading the way with ratings

Good on Defaqto. Without too much fanfare, the investment research outfit launched a ratings service for investment companies last month, extending the service it has offered for years on open-ended funds. Consumer demand for investment companies is booming, Defaqto points out, so investors should have access to the same expert analysis that they routinely get when comparing other types of collective investment vehicles.

Defaqto’s ratings are based on risk-adjusted performance, relative cost, manager longevity and scale. On the first three of those criteria, it seems likely investment companies will be more likely to earn the highest ratings than their open-ended counterparts. After all, the sector has a long and proud history of delivering better returns than equivalent open-ended funds; it has also tended to be cheaper, though that dynamic has shifted in recent years; and managers in the investment companies universe certainly tend to stick around for longer.

As for scale, it will be interesting to see how Defaqto makes its judgement. For some years now, investment platforms have been anxious about including smaller investment companies on their lists of recommended funds. They worry about the liquidity of these funds – where it is limited, a buy recommendation could move the price to a point where the case for buying no longer stacks up.

In truth, this has long been a controversial argument. Some in the investment companies sector believe it is a hangover from the past, when intermediaries looked down on investment companies because they paid no commissions. Only a small number of specialist funds lack the liquidity to justify inclusion on buy lists, they argue, and these are the sort of vehicles that probably wouldn’t be suitable for generalised recommendations in any case.

Still, whichever side of that argument you take, there is no denying the evidence that more retail investors than ever are interested in the investment company sector. They like its outperformance and corporate structures; they welcome the dependable income many funds offer; and they relish the access it gives them to alternative asset classes, such as infrastructure and private equity.

In which case, investment platforms and other intermediaries are going to have to find a way to give people what they want. Defaqto’s introduction of investment company ratings is a case of supply following demand. Platforms will come under pressure from their customers to follow that lead – to feature a wider selection of investment companies in the funds they recommend.

Investment companies themselves can do their bit, of course. One reason why we saw several fund mergers last year was that investment company boards now recognise a certain amount of scale is needed for viability. It is also encouraging to see more investment companies reducing their charges in response to the price cuts across the open-ended fund sector in recent years.

Ultimately, however, if a fund offers a compelling investment story that might interest investors, it deserves a place on a platform’s buy list – or a top Defaqto rating – however large or small it might be. Why should investors not hear about such opportunities simply because platforms haven’t found a way to tell them about it?