Poor evaluations lead to toxic investments

The record of some research houses in rating investments is patchy, to say the least. Research houses are the gatekeepers that provide ratings on a range of investments, from managed funds to shares, and are relied upon by financial planners and investors. Research houses have recommended investments that have failed spectacularly.

While nobody can expect a research house to get it right all of the time, some of the worst blunders have involved the researcher being paid by the investment provider. Some research houses are paid thousands of dollars by property developers, fund managers, super funds and investment-scheme promoters to rate their investment products.

The Australian Securities and Investments Commission (ASIC) has tightened consumer protections. In late 2012, it released new guidelines for research houses. Where research is paid for by a product issuer, ASIC expects the researcher to prominently disclose this, preferably on the front or covering page of the report. It also required better management of any conflicts of interest.

At the time, ASIC said it had serious concerns about the quality of research, particularly in light of various investment failures that had been rated highly.

ASIC is planning "targeted surveillance" of research report providers to assess the industry's compliance with the new guidelines. "If standards do not improve, ASIC will revisit the regulation of research report providers and consider whether specific law reform is needed."

But the Financial Planning Association (FPA) thinks more does need to be done.

In a submission to the current Senate inquiry looking at the performance of ASIC, the FPA says the regulatory oversight of research houses is not effective in protecting consumers, "given the influence research houses have, either directly or indirectly, on consumers' investment decisions".

As an example of the failings of research houses, the FPA pointed to the collapsed Australian hedge fund Basis Capital.

"Basis received glowing reports and high ratings from several research houses. This influenced financial planners' views of the product and consumers decision to invest in the product," the FPA says in its submission.

In the case of superannuation fund Trio Capital, which failed in 2009 and involved fraud, the research houses relied on the information provided by Trio and failed to "conduct their own independent investigations", the FPA says.

Research houses have a variety of business models and cannot be tarred with the same brush. Some are free of conflicts of interest. Others have business models that continue to rely on fees from the product providers. But the fact that the FPA says more needs to done to protect consumers should give the Senate committee food for thought.