Author Richard Sheen
It would be true to say that this has been an "interesting" year for the funds management industry in the UK and Europe as a whole.
New fund IPOs on public markets have been few and far between. Civitas Social Housing, a REIT focussed on social housing, raised an impressive £350 million on its market debut. Earlier this month, BB Healthcare Trust raised £150 million on its IPO, but there have not been many new issuers seeking to float and a number of deals have been shelved or delayed.
That said, equity markets have generally been more resilient than expected against the backdrop of the Brexit vote in June and the recent US election results. We have seen relatively strong demand for secondary fundraisings with the year seeing substantive issues for well over thirty listed funds, including Starwood European Real Estate, 3i Infrastructure, John Laing Infrastructure, Bluefield Solar, The Renewable Infrastructure Group, Amedeo Air Four Plus, Next Energy Solar Fund and Greencoat UK Wind.
The majority of the secondaries continue to support the trend that investors are most interested in achieving a pre-determined level of yield. This has very much been the key theme of the closed-ended listed market for several years now.
Evidence suggests that fund managers are continuing to assess the likely impact of Brexit on their product manufacturing and distribution models with some planning for the "worst case" scenario. It was recently reported that Central Bank of Ireland has seen an increase in the number of authorisation enquiries and applications from UK firms preparing for the possibility of the loss of passporting rights.
Managers are also assessing what sort of solution could be afforded by post-Brexit UK regulatory equivalence in the absence of single market membership and, also, the extent to which UK asset managers will be able to delegate key activities back to their UK operations. Regarding the question of regulatory equivalence as a solution, this would require that UK regulation keeps more or less in step with that in the EU, which is something that may be difficult going forward or for the FCA to live with - its recent interim report on its investigation of the asset management industry, which identifies what it considers to be weak price competition among active asset managers, suggests that the FCA is keen to remain a very much independent regulator with a focus on the particular market dynamics of the UK industry. We cover this interim report in more detail in an article by Simon Lovegrove.
In terms of consolidation, it seems that further deals or ties ups are expected including potential transatlantic deals in the vein of Henderson Global Investors and Janus Capital. In Europe, Amundi entered into exclusive talks with UniCredit to acquire Pioneer Investments. We would not be surprised to see further deals announced in the new year. Fee pressures (both client driven and as a result of any future action originating from the FCA's interim report) will see even greater emphasis on the achievement of economies of scale and could lead to an acceleration in M&A activity. Asset managers are still considered to be good acquisitions for financial investors given their relatively robust financials and low capital requirements.
Looking ahead to 2017, in addition to the Brexit uncertainties and current and prospective European political developments and uncertainties, the macro economic environment will continue to present many challenges for fund managers. More visibility on the likely shape of Brexit planning by asset managers may be achieved as we go throughout the year and some changes in business models and further market consolidation may become apparent. Fund managers seeking to launch new funds or raise secondary money are keeping their fingers crossed that the markets remain open and receptive.
The final Autumn Statement
Author Andrew Roycroft
Although the Autumn Statement was perhaps most notable for the very limited number of new tax changes which were announced, there were some of interest to the asset management sector.
In delivering his first fiscal event, the UK’s new Chancellor Philip Hammond announced it would be his last. That did not signal his departure from the role, but rather that the Budget will be delivered in the Autumn in future years. There will no longer be a Spring Budget, with a much reduced statement taking its place.
Although the Autumn Statement was perhaps most notable for the very limited number of new tax changes which were announced, there were some of interest to the asset management sector, and many of the proposals which had previously been consulted on will proceed; some of these (particularly the limit on the use of carried forward tax losses and the new cap on corporation tax relief for interest expense) could be significant for investee companies which are managed. Potentially more welcome news is that the UK’s participation exemption (substantial shareholding exemption) from corporation tax on the sale of trading companies/sub-groups is to be relaxed, by removing the requirement that the seller be part of a trading group (a requirement which can be difficult to confirm). Other proposals, such as the penalties for ‘enablers’ of defeated tax avoidance schemes, have been modified to address concerns expressed to the Government.
In terms of new developments, much of this increases the tax burden of employing staff. The Government is lowering the threshold for employers’ national insurance contributions, to align it with the (lower) threshold for employees’ national insurance contributions. This is in addition to removing the PAYE/NICs benefits of salary sacrifice (with certain notable exceptions, such as pensions, and a transitional period for others – school fees, cars and living accommodation provided under existing arrangements) and, from 2018, restrictions on the tax exemptions for termination payments.
The tax reliefs for “employee shareholder shares” (shares worth between £2,000 and £50,000, awarded in return for giving up certain employment rights) are to be removed, but not retrospectively. As such arrangements have been used for executives, there has been concern that it was not achieving its original objective. The previous Chancellor responded by limiting the capital gains tax exemption to £100,000 but Chancellor Hammond has gone further by removing it entirely for shares issued after 1 December 2016. However, those who received their employee shareholder shares before then will continue to qualify for the tax exemption, even if they dispose of the shares in the future.
There were several announcements specific to certain types of fund, including a denial of the income tax relief for performance fees incurred by offshore reporting funds (instead, those fees will be taken into account in the capital gains tax payable when an interest in the fund is disposed of). A more positive development is the announcement that tax-exempt investors in alternative investment funds (AIFs) (such as pension funds) will qualify for tax credits in respect of distributions paid to them by the AIF; the tax credit will be for income tax paid by the AIF in respect of its income. This is described as modernisation, and draft legislation is expected in early 2017. Following a consultation earlier this year, the Government also announced changes to clarify the entitlement to capital allowances, and certain other aspects of the tax treatment of, investors in co-ownership authorised contractual schemes (ACSs) in offshore funds
The property sector is subject to yet more change, with a consultation on changing the basis on which all non-resident companies are subject to UK tax on their UK income – moving from income tax to corporation tax might result in a lower tax rate, but also brings them within the scope of the cap on relief for interest expense. This will be particularly significant for investors which are highly geared.
FCA Asset Management Market Study
Author Simon Lovegrove
On November 18, 2016 the FCA published its much anticipated interim report on its asset management market study. The FCA’s main finding was that the evidence it had collated suggested that there was weak price competition in a number of areas of the asset management industry.
In the FCA’s Business Plan 2015/16 the regulator announced its intention to undertake a market study into the asset management market. The aim of the market study would be to understand whether competition was working effectively to enable both institutional and retail investors to get value for money when purchasing asset management services. The announcement in the Business Plan followed the FCA’s wholesale sector competition review where questions had been raised about the asset management value chain.
In November 2015 the FCA published its terms of reference for its market study into the asset management market. To allow the FCA to understand how asset managers compete on value, the market study would focus on the following questions:
- How do asset managers compete to deliver value?
- Are asset managers willing and able to control costs and quality along the value chain?
- How do investment consultants affect competition for institutional asset management?
- How do investors choose between asset managers?
- How does the current market structure affect competition between asset managers?
- How do charges and costs differ along the value chain?
- Are there barriers to innovation and technological advances?
The deadline for comment on the FCA’s terms of reference was 18 December 2015. Following this date the FCA began work on its market study.
Meeting investors’ expectations
An indication as to the FCA’s views on the market were brought to light in April 2016 when the regulator published a reminder to asset managers regarding the importance of meeting investors’ expectations. The FCA had considered whether UK authorised investment funds and segregated mandates were operating in line with investors’ expectations as set by marketing and disclosure material, and investment mandates. The assessment was made against FCA rules and did not focus on fund performance. In the sample of funds reviewed the FCA found that some were not providing a clear enough explanation of how they were managed. The FCA gave the example that some had failed to disclose a constrained investment strategy and one included jargon that ordinary investors were unlikely to understand.
The FCA reminded asset managers that they must have appropriate oversight to ensure that the fund is being managed in accordance with the stated investment policy. The FCA also reminded asset managers that they have a responsibility to ensure that their funds are sold appropriately through third parties. The FCA gave as an example two funds that were available on execution-only platforms despite the asset manager having planned for them to be available only with advice.
All asset managers were asked to consider these matters and review their arrangements.
FCA interim report delayed
When the FCA’s terms of reference were finalised the regulator stated that it would produce an interim report during the summer of 2016. However, in August the regulator announced that the interim report would be delayed until Q4 2016. Some in the media speculated that the delay was due to the regulator’s investigation into absolute return funds which had proven to be popular with investors despite having posted negative returns in 2016. This, it was said, had led to concerns about how the funds were being marketed to investors.
The interim report published
The FCA’s interim report was published on 18 November 2016.
The FCA’s main finding was that the evidence it had collated suggested that there was weak price competition in a number of areas of the asset management industry. This had a material impact on the investment returns of investors through their payments for asset management services.
Competition between asset managers
Mainstream actively managed fund charges have stayed broadly the same for the last 10 years whilst charges for passive funds have fallen over the last 5 years.
There has been considerable price clustering for active equity funds, with many funds priced at 1% and 0.75% particularly once assets under management are greater than around £100m. The FCA reports that “this is consistent with firms’ reluctance to undercut each other by offering lower charges.” The FCA also notes that as fund size increases, price does not fall, suggesting the economies of scale are captured by the fund manager rather than being passed onto investors in these funds.
Cost control was mixed with asset managers tending to be good at managing charges which are straightforward and inexpensive to control (for example negotiating fees down for services such as safekeeping of assets and other ancillary services) but less good where it is more expensive to monitor value for money, such as how well executed trades and foreign exchange transactions are. Fund governance bodies were also not exerting significant pricing pressure by scrutinising asset managers’ own costs.
- Actively managed funds do not outperform their benchmark after costs.
- Funds which are available to retail investors underperform their benchmarks after costs while products available to pension schemes and other institutional investors achieve returns that are not significantly above the benchmark.
- There is no clear relationship between price and performance – the most expensive funds do not appear to perform better than other funds before or after costs.
Transparency and clarity of objectives and investment outcomes
- There had been some progress made on transparency of charges including the introduction of the Ongoing Charges Figure, the current FCA consultation to introduce a standardised methodology to calculate transaction cost for defined contribution workplace pensions and work to unbundle research and dealing commission.
- Ancillary services bought by managers, such as administration and services to safeguard assets, were usually clear to investors but some investors were not given information on transaction costs in advance meaning that they cannot take the full cost of investing into account before making their initial investment decision.
- Some fund managers do not adequately explain their fund’s investment strategy and charges.
- Many absolute return funds do not report their performance against the relevant returns target. Also, some charge a performance fee when returns are lower than the performance objective the fund is aiming to achieve.
- There was broad agreement that value for money for asset management products is seen as a combination of the: (i) return achieved; (ii) price paid; (iii) risk taken; and (iv) quality of any additional services provided by the asset manager. This means that most investors generally think of value for money as risk-adjusted net returns.
- A key focus for retail investors and, to some extent, institutional investors when choosing between asset managers is past performance. However, the FCA believes that past performance is not a good indicator of future risk-adjusted net returns.
- Whilst there is increasing attention among institutional investors to the level of charges that they pay, many retail investors are unaware that they are paying these.
- It is often difficult for investors to know whether they would be better off switching providers and in some instances retail investors were remaining in persistently poor performing funds.
- Asset management firms found it difficult to move investors into newly created share classes even if it was in the best interests of the investors. This was generally because investor consent is needed to transfer to an alternative share class, and many investors do not respond to communications.
Ability to negotiate
- Fund governance bodies acting on behalf of retail investors do not typically focus on value for money.
- There were a large number of small pension schemes and trustees which vary in how effective they are at negotiating price.
- Retail investors did not appear to benefit from economies of scale by pooling their money together through direct to consumer platforms. The FCA has concerns about the value provided by platforms and advisers and is proposing further work in this area.
- Investment consultants’ ratings influence which asset managers institutional investors choose. However, these ratings did not appear to help institutional investors identify better performing managers or funds.
- Whilst larger institutional investors are able to negotiate effectively with asset managers, investment consultants do not appear to help smaller institutional investors negotiate or otherwise drive significant price competition between asset managers.
- The investment consultancy market is relatively concentrated and levels of switching in the market are low. Moreover, many institutional investors struggle to monitor and assess the performance of the advice they receive and whether investment consultants are acting in their best interests.
- Investment consultants are expanding into fiduciary management combining advice, governance and carrying out investor instructions which means that they are both distributors for – and competitors to – asset managers, posing a conflict of interest. The FCA believes that further investigation is needed in this area and is consulting on making a market investigation reference to the Competition and Markets Authority (CMA).
Unsurprisingly, the FCA believes that there is room for improved outcomes in both the institutional and retail parts of the asset management market. It therefore proposes a package of remedies:
- A strengthened duty on asset managers to act in the best interests of investors, including reforms that will hold asset managers accountable for how they deliver value for money, and introduce independence on fund oversight committees.
- The introduction of an all-in fee approach to quoting charges so that investors in funds can easily see what is being taken from the fund.
- To help retail investors identify the best fund for them by: (i) requiring asset managers to be clear about the objectives of the fund and report against these on an on-going basis; (ii) clarifying and strengthening the appropriate use of benchmarks; and (iii) providing tools for investors to identify persistent underperformance.
- Making it easier for retail investors to move into better value share classes.
- Requiring clearer communication of fund charges and their impact at the point of sale and in communication to retail investors.
- Requiring increased transparency and standardisation of costs and charges information for institutional investors.
- Exploring with Government the potential benefits of greater pooling of pension scheme assets.
- Requiring greater and clearer disclosure of fiduciary management fees and performance.
- Consulting on whether to make a market investigation reference to the CMA on the institutional investment advice market.
- Recommending that HM Treasury considers bringing the provision of institutional investment advice within the FCA’s regulatory perimeter.
- Further FCA work on the retail distribution of funds, particularly on the impact that financial advisers and platforms have on value for money.
The deadline for responding to the interim report is 20 February 2017. A final report and proposed amendments to the FCA’s rules are expected in Q2 2017.
In light of the FCA interim report, some active managers may find themselves under more pressure as to how they market their funds to investors and may receive more questions on the real substance of their strategies.
The proposed “all-in fee” approach taking in all costs is intended to improve transparency and competition among asset managers but has been criticised by some in the market on the basis that it would be tougher than anywhere else in the world. The FCA has invited comments on four possible different models, including a proposal for asset managers to be forced to pay any costs incurred above the explicit fee charged to investors. With each possible approach there are advantages and disadvantages and some in the market have suggested that the best course of action would be to set a high level principle and let the consumer decide on the approach they prefer.
For investment consultants, the prospect of a market investigation reference to the CMA will require careful consideration and positive engagement with the FCA during the consultation period.
Arguably, the publication of the interim report is an important moment for the fund management industry and may challenge the fundamentals of the investment management model. Whether the interim report becomes a defining moment for the industry remains to be seen.