Disruption is a tough road, especially in a sector like financial services where powerful vested interests reign. But upstart Fundhouse successfully turned the investment fund rating model on its head in its native South Africa. And after six years in London, is breaking through in the far bigger UK market. Founder Rory Maguire explains how he came to adopt a model where users of his firm’s independently compiled ratings put their hands in their pockets – rather than the existing system where the money managers themselves pay those doing the rating. It’s a very big spoke in the status quo, but much fairer to the public and one that has attracted the attention of British regulators. It often takes an outsider to force changes onto a comfortable status quo. Maguire, who was CEO of SA asset management company RECM, explains how he is making this happen in his adopted homeland. – Alec Hogg
Rory, itâs an interesting story. You were at RECM in the early days and then moved on from there, but that was an asset management company, youâre doing something very different.
Yeah, Alec, itâs very good to be here. Yes, Fundhouse is a business that has strong links back to asset management, but isnât itself an asset manager. So yes, very simply we are a business that does fund research and then packages that fund research up into portfolios for our clients as well, so itâs those two services we offer our clients and our clients tend to be for the most part, financial advisors and other sort of aggregators of advisors, fund platforms, wealth managers, and life companies and those sorts of businesses.
Yes, youâre being very modest. Itâs a highly disruptive business; you have a different model to everybody else, how so?
Yes, well most people in our space make a living off the fund groups in some shape or form.
Is that in an asset management company, money managers?
Yes exactly, the investment managers, so if you are in the business as we are of providing fund research to the market, a public service, in other words, where youâre rating numerous funds for the market, most of our competitors get paid by the fund groups. In other words, the rater, a business like ours gets paid by the ratee and I donât think it takes much to work out that, that is a conflict and how that plays out though, in other words you may say to yourself, âWell, itâs a conflict, but so what?â. Well the big âso whatâ that happens in our industry is thereâs a complete and utter absence of negative fund ratings and in a world where active fund managers, as good a job as they do, if we do face the facts, more often than not they donât deserve the fee they get paid, they do underperform more often than they outperform.
We know exchange traded funds, for instance outperform active managers, they have to.
Yes, 66%, thatâs right. Itâs a mathematical given that active managers will underperform. They charge a higher fee and if we assume that the market is an aggregate of investment managers typically, both passive and active that an active manager, if they are part of the average is always going to underperform because of their bigger fee. So they do underperform on average, but there are many that do deserve the fee and do, do well and itâs a business like ours that needs to, I think separate out the good from the bad. We are, in, I would say a small minority. I think weâre the only ones we know of who offer the service that we do that has a big chunk of critical ratings across many funds that we look at.
How many of the funds that you would analyse would have a negative rating?
Itâs interesting, itâs not enough actually. We just did the analysis yesterday, Andrew and I, looking at the numbers. The current numbers are sitting probably around a third, which if you were thinking about it rationally, youâd say âWell why isnât that number greater than 50%?â given what you and I have just spoken about and that probably means weâre probably a bit too soft actually. We probably should be a little harsher. Itâs sitting around at third, but we do have a middle range of funds as well which is also another third, so itâs about two thirds of funds that donât rate, letâs say our top rating, so we have a middle range, which is sort of a neutral, slightly positive and then a third or the bottom third that is negative, but yes, itâs about a third, which is still a third more than everyone else, but itâs a number that I think over timeâs probably going to go up not go down.
You started Fundhouse in South Africa, how strong are you in that market?
I think weâre strong. Youâre asking me a question here which I have to struggle not to be too humble, I guess, but weâre a business that I think is probably the dominant independent fund research business there, and I say independent, probably across all fund research businesses and we started in 2007. Weâve been going there for nine years now, a very proud accomplishment. It took a lot of time and effort to get us there. There were early days where we thought things werenât necessarily going to work out. I remember days where we got salaries of R1, Pete and I. I think weâve still got those payslips, but itâs worked out and I think in the end it is disruptive because itâs gone to the market and asked clients to pay for something as they should rather than fund groups.
Weâve offered a very independent service that I think has disrupted that market and is now, I think considered to be a mainstream service. If you look at the UK for example, weâre a minority player in the UK and hopefully that wonât be forever. The idea is to do the same thing here as we did there, but weâre back on the same starting point where weâre trying to disrupt again and do the right thing for the client and put forward a proposition that I think is quite scary to the fund managers initially because it is the first time theyâve ever seen something critical, dare I say it, but over time hopefully the right thing for the client plays out and everyone wins.
When did you start in the UK?
In 2010, six odd years ago now and the thing with our type of business is, you canât go to the market with a product unless youâve actually done the fund research. For the first couple of years we werenât marketing, we had doors closed and a whole bunch of analysts sitting there, actually researching funds, so that we actually go to the market a couple of years later. We only regulated in 2015 with 200 odd funds. If you donât have 200 funds (thatâs the magic number), you basically canât open your doors and thatâs kind of where weâre at. We have a bit more than that now, but it took a whole lot of time and effort to actually get that number up to the point where we get out on the market and say âHey, weâve got a product, donât you want to take a look?â
Do you have critical mass here?
Yes, I think we do. As a disruptor or a business that always wants to maintain the attitude of being small, even if we end up being big, as I suppose we are in South Africa Iâm never comfortable with words like âcritical massâ. We always want to feel like we are up against it a bit. When the worldâs going left, we still want to be able to go right and thatâs important to us, so yes, we have critical mass, we have clients and we have fantastic penetration into this market, far more so than we probably expected if Iâm honest at this sort of stage. While itâs taken a long time, the sort of clients we have, weâre very proud of, but we always want more and I think hopefully if we get to speak to you in a year or twoâs time, weâll have a whole lot more clients and maybe closer to that critical mass, but never quite there.
Disruption is a difficult way of making a business. Why did you do it this way? There are just so many softer, easier ways of making money.
Yes, I know. You just have to ask my family about that. I mean, the whole time and I guess you know about that too, is youâre selling a bit of the farm to try and get a point of principal across to some marketplace and weâve been doing that for a long time and the farm is getting smaller and smaller and slowly but surely hopefully building a business at the same time. The reason we do it though, is that if you look at financial services as an aggregate you find so many ways, in our view anyway where you can improve the outcome to a client and be disruptive at the same time.
Those moments donât exist if youâre in the restaurant industry or the wine industry, but in financial services there are many moments where you find, for example, fund rating is a service where itâs a service to Peter, the financial advisor, paid for by Paul, the fund group. Itâs like a no-brainer, you could go in there and disrupt and you end up doing the right thing. Thatâs what drives us I think and I mean, as we get further on in our career is more a sense of making an impact than sort of how much profit we get. Profit sort of follows the disruption component of it, so as long as weâre disrupting in the direction of the client, thatâs key.
It is a shared value business model. I donât know if youâve done much analysis on that, but Michael Porterâs spoken about it, itâs a discovery of the flag waver internationally of the shared value business model, but you have to wonder why ratings agencies who rate companies havenât also been following this particularly after the global financial crisis.
Well, I think we know why and itâs an indictment, I think on that part of the industry in a sense that putting aside movies like âThe Big Shortâ that may have highlighted this in a slightly comedic way, but S&P at the moment, is being sued by the SEC. I think itâs $1.5bn alongside a lot of the other credit rating agencies for giving out rosy ratings that the SEC thought were given because they were in a commercial relationship between the rater and the ratee. Thatâs what happens. Youâre in a commercial relationship.
Whatâs going to happen if we think a fund is a negative fund in the same way that they should have rated some mortgage-backed securities perhaps down, but the guy sitting opposite you is paying your rent, what are you going to do? Thatâs the issue theyâve had and it causes these distortions in markets that we saw play out in a terrible way in 2008/2009. They havenât changed that model, in fact, the MD of Fitch, I forget the quote, I forget his name, but he basically said you canât stop now because the bus has left the station and if you do stop that model, you have no rating agencies. That doesnât really help the client very much, but that is a potential problem for the market if we donât get in soon enough.
So at least on the funds or the unit trust side of mutual funds, what other kinds of funds do you rate?
We rate all sorts, we rate active, we rate passive. In the UK there are things called investment trusts which are closed-ended vehicles much like the sort of private equity vehicles you get in South Africa, ETFâs, open-ended investments in the UK, the whole lot, but anything which is an aggregate of investor assets inside a fund, a co-mingled fund of sorts whether open-ended or closed-ended, we look at across the spectrum. So whether itâs a traditional asset class like equities or bonds, the multi-asset space or even the less traditional space infrastructure, property, private equity, hedge, take your pick, the whole thing.
Who would your competitors be here?
The competitors in the UK, thatâs a good question. We probably see businesses like Mercerâs more as peers. That certainly we seem to unseat a bit, but the biggest competitors I think in the mind of the market and the ones that weâre probably disrupting the most, Morningstar, businesses like Square Mile, Rayner Spencer Mills, those sorts of businesses.
They would be paid by the funds that they are analysing or rating for the service?
Yes, I wouldnât want to speak out of turn on their behalf, Iâm pretty sure of that fact, but they are in a commercial relationship with the fund groups and weâre not and that commercial relationship is this, they will sell the fund group the right to use the rating on their website, on their fact sheet or whatever it is, which enables the marketing. So if you speak to the fund groups, I think itâs usual that the fund groups see those entities as an extension of their distribution or their sales teams, which is why itâs very hard across our competitors to find anything critical and negative said about funds that we often are quite outspoken about and thereâs lots of examples of those, but yes, those are probably, I would say our main competitors in the UK market that we could hopefully disrupt over time.
You donât mind it being unpopular?
No, I mean, what did Churchill say âIf you havenât upset people, you havenât stood for anythingâ, but no, I am particularly uncomfortable being popular. Itâs not to say weâre antagonistic or rude or anything. Thatâs not what weâre trying to be in any shape or form. I think if you met us, hopefully you wouldnât think we were an arrogant, dogmatic bunch, but we know what we stand for, we know we want to do the right thing and I think in financial services sometimes that puts you up against some of the big guys and some of the big names. That makes you unpopular, but I think thatâs okay if youâre doing the right thing.
Do you think youâre making progress, do you think people are taking note and saying âMaybe the model that does exist isnât the right oneâ?
I do. We have good evidence of that, so we have, for example, the FCA in the UK, the regulator here anyway. They regulated us, weâre the first to be regulated to do what we do, and no one else as far as we know is regulated for fund research. They specifically asked us to be regulated as part of this thing called Project Innovate for disruptive businesses and I think theyâre taking notice. We had them in the office, gosh less than a week ago I think, and they were the ones talking to us about the fact that weâre the only ones that are regulated.
They know and hopefully, I donât think the door is going to open from the inside, I donât think the fund groups are going to wake up, and say âHang on, letâs stop paying these guysâ. I think that door opens from the outside and the FCA and perhaps businesses like ours have the keys to that door, but I do think over time, people know our modelâs the right model, itâs just I guess, up to us to get to critical mass to prove to them that weâre worth listening to, which will hopefully, I think then cause others to maybe copy us, which wonât be a bad thing and effect behaviours, which we want to do.
How did the other model develop, where did it come from because the way you explained it and itâs pretty clear you canât be objective if somebody is actually paying your salary.
Yes, so the other model started back in the day on the back of the credit rating agency, so S&P, Fitch and a few others had this model and I think the dominant player in the UK, I would say ten years ago was S&P. They had a slightly different model, which was if I come and rate you Mr Fund Managers; you will pay me for that. They quite cleverly have changed the wording on the invoice now and S&P is no longer a dominant player at all, but theyâve kind of changed the wording on the invoice of the fund manager now to say well, youâre going to pay for the marketing rights of that particular logo and so itâs a slight softening in some ways, but I think at the end of the day when youâre getting paid by a fund group, itâs a very hard thing to maintain your objectivity. I donât think thatâs a point that can be disputed.
Where does the money come from, who pays the check?
Well, I mean thatâs the point. Itâs really important, I donât want to drum on about it and sound like Iâm overly dogmatic, but this is not Trip Advisor, this is not a scenario where… weâre not selling jeans, weâre in the business, I think of trying to enable people to retire with dignity. In a world where the stakes are that high, I think removing all the influences on your decisions that could, I guess, get you away from doing something thatâs objective is really important, which is why I feel strongly about it. There are lots of models where you have a service paid for by Person A and it gets delivered to Person B. Iâve mentioned some of them already, but I think in financial services thatâs dangerous.
On the other end of the spectrum you also have to have people who are prepared to pay for this independent advice, because presumably the financial advisors themselves would have all kinds of pressures (financial pressures, commercial pressures) on them to support various asset management companies.
Yes, thatâs right and I think we say this internally as well, is that people donât buy us because they like the ethic of it. If our product was the same as everyone elseâs, I think we would struggle to sell anything. We have a product that is in itself on a standalone basis hopefully seen as being an improvement on what exists. Our clients must decide whether thatâs right or wrong, whether we are an improvement, but we try our best to make the product better and then the additional selling point becomes the sort of independence of it.
Many of our clients, youâre right, theyâre getting stuff for free from our competitors, so why should they pay for it from us and I donât think that they would only buy it for the conflict of interest issue that we raise. So we try, for example, our reports are 20 pages long, we work for pension funds, we work for live companies on the same basis as a man on the street. Thereâs no difference in service level between the two and I think thatâs the big differentiator, where as I said, we compete with Mercerâs more in our minds, certainly I think thatâs the playing field weâre in, weâre just bringing the product into the retail space.
Rory, do you think being a South African, being an outsider to the British cultural class system has helped?
Itâs hard to say, I think itâs both a help and a hindrance. I think itâs a help in that we, I think, as South Africans and I having worked with a lot in the UK, my colleague Andrew being one as well, I donât know if itâs a weird thing to say, but thereâs a special sort of drive that exists. We are people that I think work really hard and havenât been given too much too easily and I think that helps a lot. Thereâs a motivation there and a willingness, a drive, a determination to try and effect change. As to whether that enables you, does the South African component enable you in this market, I donât think itâs a massive disabler, but I do think the next person we employ in the UK is going to, certainly from our clientâs servicing perspective, just to tell our clients that we are here to stay, is to employ some English accents and weâve found doors being very open.
The people here in England love South Africans. Itâs been brilliant for us. You take someone like Hendrik du Toit, an Afrikaans-speaking South African who has built the most remarkable investment business in London, his entire equity team pretty much walked out in, was it in 2003 that team walked out, they got by-ratings from all the consultants. He had pretty much nothing to sell as far as I remember and what, 14 or 13 years later heâs sitting with one of the most remarkable top ten fund management businesses in the UK. I just, you know being South African is an excuse, I donât think itâs a good excuse. I think we can do it and thereâs great evidence we can.
