Financial advisers who are frustrated over perceived shortcomings in mutual-fund- rating systems soon will have a new prism through which to view funds.
Financeware Inc. of Richmond, Va., introduced Fundgra+des last month.
The firm's ratings, which are available free of charge at fundgrades.com, grade funds on an A-to-F scale based on five criteria: diversification, expense, relative risk, return and underperformance risk, as well as giving an overall rating.
Financeware has had success in the industry. The firm's Envision software program is a goal-based, wealth management Monte Carlo advising and monitoring program that was released in 1999 and has been used firmwide by Wachovia Securities LLC of Richmond, Va., since 2003.
Under the Fundgra+des system, a fund that scores well on return may get an F in risk because it is more volatile than its benchmark.
"There was a void in the marketplace for something that paid attention to something other than peer groups," said David Loeper, chairman and chief executive of Financeware.
While that remark seems to be a swipe at the peer-based rating system used by Chicago-based Morningstar Inc., he insisted that Fundgra+des is complementary rather than a rival.
"It's not competition. Fundgra+des provides different information with a different perspective," Mr. Loeper said.
"It's supplemental and additive," he said. "In some cases, we may have similar opinions, and in some, we may expose information that the other rating system doesn't."
John Rekenthaler, Morningstar's vice president for research and new-product development, contends that peer-to-peer comparisons are the fairest way to compare funds, as they eliminate differences in assets, geography, market size and style.
"You are homing in on whether this manager had success in picking better stocks than the other managers," he said.
Mr. Rekenthaler thinks that the Morningstar and Fundgra+des systems are similar.
"There is a lot of overlap between what we are doing and what they are doing, generally leading us both to similar conclusions about funds," he said.
Mr. Rekenthaler noted that Fundgra+des rates diversification, or how closely a fund tracks its relevant index — a measure that isn't used by Morningstar.
"It is a good measure if you want to buy one fund and make sure it isn't dangerous," he acknowledged.
Meanwhile, Lipper Inc., a New York-based mutual fund research firm, is revising the numbering system for its ratings. Next month,the Lipper Leader Rating System will reverse its performance order; a 5 rating will be now be Lipper's top grade, instead of a 1.
"We wanted to create a more flexible and marketing-friendly set of icons that better suit the marketing needs of fund companies," the company said in a statement when it announced the change over the summer.
Late last year, Lipper said that it was considering the introduction of a new fund classification system.
"We are constantly looking at our classification system," said Eric Almquist, Lipper's chief operating officer.
But Emily Chang, a spokeswoman, said no change is pending at this time.
To classify funds, Lipper uses two processes.
For diversified-equity funds, the firm looks at portfolio composition, watching where the bulk of the assets were invested over the past few years, said Jeff Tjornehoj, a senior research analyst. For non-diversified funds, such as bonds or sector equity, Lipper looks at prospectus objectives.
Lipper's measures include total return, consistent return, preservation, tax efficiency and expense, said Mr. Almquist, noting that the comparison is among peers.
"Is it the only way to do it? Probably not. Is it helpful? Yes," Mr. Almquist said.
Another company, New York-based Value Line Publishing Inc., is sticking with its 1-to-5 rating system, with 1 as the highest grade. The firm highlights growth persistence and return relative to risk in its ratings.
"The growth persistence piece is unique to us, to my knowledge," said Value Line research head Sam Eisenstadt.
"Our rankings are more directed at performance," he said. "It's important that the fund not only outperform the market but that it does so persistently."
Neither Mr. Almquist nor Mr. Rekenthaler view Fundgra+des as competition.
"Essentially, our business is pretty well established. Anything that helps the industry, I applaud; if it can help investors, it's good," Mr. Almquist said.
Mr. Rekenthaler said: "Fund research is not an either/or game. There is much more to us than our rating system."
In any event, advisers seem to be looking for more than ratings.
"The ratings systems ignore the biggest issue: how a fund interacts with the rest of the portfolio. Fund ratings don't fit in at all with portfolio construction, and a large part of return is related to asset allocation," said F. John Deyeso, a financial planner with New York-based planning firm financial filosophy.
"Investors have been deluged with this information, and no one is talking about risk," he said.
Another complaint is that ratings encourage performance chasing.
"Ratings systems, and particularly the star rating systems, kind of hurt the clients before they get to me and my firm," said John Augenblick, a New Hope, Pa.-based financial adviser with Toal & Associates LLC of Annapolis, Md.
"The systems do not address the correlation between the asset classes. The problem with peer asset class evaluation is that even within that group, there are certain funds that are more volatile," Mr. Augenblick said.
"There is no way to break out the risk-adjusted returns," he said.
The Fundgra+des program, however, does answer some of these questions, Mr. Augenblick said.
"It's great that he has included the correlation of the mutual fund to all of the different classes; I like that he has the relative risk," he said. "But the diversification grade seems counterintuitive."
Sue Asci can be reached at [email protected].
