The war of words between Canadas mutual fund association and independent fund research firm Morningstar escalated today when the latter issued a rebuttal to a critical letter the Investment Funds Institute of Canada (IFIC) had distributed widely to its members.

The first IFIC point is that Morningstar appears to take the stance that firms that believe in advice and deliver investment products through the advisors should be penalized.

Mackenzie replies in part:

Morningstar analysts do not believe that advisor-based firms should be penalized in the stewardship grades . while the products delivered through these channels tend to exhibit higher fees than those that do not (to account for the payment of advice), the Stewardship Grades methodology reflects this reality.

He adds that firms using the advice channel which therefore include a trailer-fee component in fund Management Expense Ratios may receive extra credit in the event that its fees are lower than those of other firms with comparable distribution strategies. He says Morningstar is a strong supporter of advisor-client relationships and that a large part of its business is centered on mutual fund research tools used by thousands of Canadian advisors.

Qualitative, quantitative or both?

IFICs next point ends: the study appears to be qualitative and subjective and presents no evidence of research into investor experience at all.

To this, Mackenzie agrees some of the study is based on qualitative factors, but adds:

it is also based on many quantitative factors. The fee section is heavily quantitative I can assure you and your members that a rigorous analytical approach was used in this research.

Usurping the regulators role?

Further into the letter, IFIC says Morningstar is attempting to impose a new regulatory standard in place of the existing robust regulatory set of standards currently active in Canada.

Mackenzie replies:

At present, none of the 27 firms we have graded have received a deduction for any regulatory issues. Our rationale for factoring in regulatory issues is not arbitary: we will take our cue from the regulators in each instance.

Value to investors? Morningstar gave non-clients higher grades than some paying clients

The new Stewardship Grades will provide no value to investors as they are not predictive of any benefits Morningstar . is attempting to insert itself as sole arbiter of what is in the best interests of investors.

Mackenzies reply:

We have no vested interest in the results of our Stewardship Grades . four of the five firms that received top marks have no commercial relationship with Morningstar, while some of our largest clients received lower grades Morningstar does not receive compensation from fund companies for grading them We believe one of the most valued qualities of Morningstar analysis is that it is independent of the fund industry.

Shooting the wounded: funds with high grades less likely to be shut down or merged

The appendixes contain a few gems as well. One is a table of U.S. mutual funds, showing a strong negative correlation between higher stewardship grades and fund closures. Funds with high grades were far less likely to have been merged or liquidated in the six years following.

Funds with high stewardship grades more likely to build wealth than destroy it

Mackenzie saves perhaps his most telling point for the third and final table in the appendix. It lists U.S. Morningstar research that shows firms with higher stewardship grades have done a much better job creating wealth than poor stewards.

The five top wealth creators are American Funds, Vanguard, Fidelity Investments, Franklin Templeton and PIMCO Funds. The top wealth destroyers are Janus (losing US$58.4 billion over ten years), Putnam, Alliance Bernstein, Invesco AIM and MFS.

By my count, at least six of those firms are represented in some capacity within IFICs membership.

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