Phil Lynch, CEO of Asset Control says it is not necessarily misplaced 'AAA' ratings that cause problems, but when that becomes the only basis for an investment decision.
Phil Lynch, CEO of Asset Control says it is not necessarily misplaced ‘AAA’ ratings that cause problems, but when that becomes the only basis for an investment decision.
Taking a swipe at credit rating agencies has become a popular spectator sport in the past few years. But all the hot air that has poured forth on discussions of potential reforms has missed the more important point. Yes, the business models of the big three in particular are flawed. Yes, the industry would benefit from greater transparency about who is selling what information and to whom. But the real problem that needs looking at is the extent to which investment firms on both buy and sell side have become dependent on those agencies as the single, authoritative source of data for making critical investment decisions.
Many of the problems that the markets and investors are now experiencing can be attributed to the practice of using a triple A rating as a stamp of good housekeeping – instead of conducting the internal research, analysis and due diligence that are the core value proposition of any investment firm. Indeed, clients shell out management fees and commission for insight and market intelligence, not generic reports from firms who have simply outsourced asset rating and assessment.
There is no alpha to be gained from using the same, commoditized data as your competitors; and when everyone acts on the same information -accurate or not – irrational behavior and unsustainable asset bubbles are the result.
Not much has changed since those bubbles burst. With the result that too many firms continue to rely on the same information, without validating it, verifying it or adding any value to it.
However, the information that credit ratings produce has its merits. The agencies have, for a long time, done a great deal of valuable work on fundamental research and analysis. And there is much to be gained by leveraging that work. But a credit agency assessment is only one piece of the puzzle. The full picture will only be gained by going into the detail, drilling down below surface-level information, comparing and contrasting multiple data sets and questioning their sources and assumptions.