This week we begin a series profiling the main UK fund research agencies, kicking off with Defaqto. Platforum research shows 24 per cent of advisers using such agencies use Defaqto, making it the fourth most popular (investment fund).

The research also finds Defaqto users typically use FE and Morningstar too. The number of advisers relying on one research agency is decreasing over time, with the average adviser now typically using two.

Defaqto offers a suite of portfolio management tools and other services to advisers through its software package Engage. More recently it has stepped into the fund research arena by launching its Diamond Ratings. Defaqto sits in our “ancillaries” category as fund research and ratings represent an additional service to its core proposition. We will be covering the other categories – “generalists” and “specialists” – over the next few weeks.

The ratings

The scope of Defaqto’s Diamond Ratings is one the broadest among research agencies, covering a large number of all types of funds, with the exception of investment trusts. The company does not rule out rating these vehicles in the future.

The ratings are both qualitative and quantitative. The quantitative element includes an algorithm run against all funds with a three-year track record, although the rule can be relaxed to two years when a fund looks set to obtain five diamonds: the highest rating given. The qualitative criteria in the algorithm encompass clarity of mandate, adherence to fund objectives and risk-adjusted performance after cost.

Many advisers use quantitative ratings to filter funds before bringing qualitative criteria into the selection process and the Diamond Ratings seem to resonate well with that.

Advisers that use Defaqto favour multi-manager funds, perhaps reflecting its focus on rating investment solutions such as multi-manager and multi-asset funds, and risk-targeted and risk-focused fund families.

The users

The Engage software is used by over 6,000 advisers. Users can access ratings on multiple products and services as well as funds, including discretionary fund managers, investment wrappers, life and protection products, and model portfolios among others. There is a monthly licence fee for Engage, although the Diamond Ratings are free to view on Defaqto’s website.

Our data shows that, of Defaqto’s users, 53 per cent access its services free of charge and 47 per cent pay for the extras. This represents one of the highest proportions of paid users among research agencies, suggesting it has been rather successful in attracting advisers to Engage. Licensing agreements with fund groups (through which they buy marketing licenses to use the ratings) represent another source of income for the firm.

Unlike most research agencies, Defaqto has chosen not to offer its own model portfolios, with a view it brings a conflict of interest. However, it does provide investment consultancy services to adviser firms to help them create their own models and fund panels, which can then be uploaded into Engage. We see evidence that the trend to outsource investment strategies is reversing. This, as well as the increasing importance of investment solutions such as multi-asset funds, should play in favour of Defaqto.

The agency looks set to increase its influence over advice firms running in-house investment strategies, especially where these include investment solutions. That said, its lack of proposition to serve advisers that do outsource makes it vulnerable if that trend was to in fact increase.

(Money Marketing, 2017)

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