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UPDATE 1-Morningstar reviewing BlackRock energy fund rating
June 8, 2012 / 7:06 PM / 5 years ago

UPDATE 1-Morningstar reviewing BlackRock energy fund rating

* Ratings agency cites potential conflict of interest

* Report advises shareholders to invest elsewhere

By Jessica Toonkel

NEW YORK, June 8 (Reuters) - Morningstar Inc is reviewing its rating on BlackRock Inc’s Energy & Resources Fund due to a potential conflict of interest regarding one its portfolio managers, the investment research company said.

Dan Rice, one of the portfolio managers of the $953 million fund, founded a natural gas drilling company, Rice Energy, in 2005. As first reported by The Wall Street Journal, a subsidiary of Rice Energy, Rice Drilling, in 2010 entered into a joint venture with Alpha Natural Resources, a holding in the BlackRock Energy & Resources Fund. Since that joint venture, the fund has increased its ownership in Alpha Natural Resources.

Alpha currently is a top 10 holding of the fund, making up 4.85 percent of its holding as of April 30, according to Morningstar.

The potential downgrade that Morningstar is considering would affect its analyst rating of the fund, a fairly recent category that is in addition to its star ratings of funds.

In a report announcing that Morningstar was reviewing its Bronze analyst rating for the fund, analyst Rob Wherry said BlackRock has made it clear that Dan Rice is no longer involved with the day-to-day business of Rice Energy, which is now run by his sons.

Wherry also said BlackRock has stated that its increased holdings of Alpha were due to Alpha’s acquisition of Massey Energy in early 2011, a top holding for the fund.

“Clear disclosure would have helped investors make better decisions about owning this fund,” Wherry wrote in his report, entitled “Stewardship issues are overshadowing this fund’s merits.”

While there has been no evidence that shareholders were hurt by the situation, “it does raise enough concerns about stewardship and future conflicts that existing shareholders should consider other category options for their new dollars while demanding information about Rice’s dealings,” Wherry wrote.

Wherry declined to comment beyond his report until he had talked to BlackRock.

A spokeswoman for BlackRock said the money manager “maintains rigorous policies and procedures to manage conflicts, including requiring employees to seek prior approval from compliance for any outside investments or business activities.”

The spokeswoman, Bobbie Collins, added, “With respect to Dan Rice, the firm also put in place additional procedures to mitigate any potential conflict involving Rice Energy, including requiring Dan to recuse himself from all decisions involving Rice Energy’s joint venture with Alpha Natural Resources.”

Chicago-based Morningstar introduced its analyst ratings in November. They are designed to complement its star ratings and take into account other factors besides past performance, such as a fund’s managers, its parent company, and its stable of analysts.

Even though Morningstar’s analyst ratings are still new and do not yet have the same weight with investors as its star ratings, a downgrade in an analyst rating is actually more significant, said David Snowball, founder of MutualFundObserver.com, which examines and critiques the mutual fund business.

“The analyst ratings are probably more predictive of the performance of the fund,” he said. “And when the analyst rating is a source of moral judgment, it may start to stick with investors.”

Observers said they were surprised that BlackRock allowed the potential for conflict of interest to occur.

“The potential for conflict of interest is there and I am surprised BlackRock’s compliance department didn’t have the same conclusion,” said Jeff Tjornehoj, head of research at Lipper.

Lipper, which takes into account only quantitative metrics for its ratings, gives the BlackRock fund a 4 rating on a 5-point scale based on its past three-year performance.

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