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 December 18, 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 on its website 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 November 18, 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 per cent and 0.75 per cent 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 lowers 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.
Some in the market have criticised the FCA’s interim report arguing that it is a deliberate attempt by the regulator to push investors, both large and small, towards cheaper passive funds. Whilst not introducing a cap on the fees asset managers charge, the FCA’s proposals are seen as a heavy blow to active fund managers. In addition, in light of the comments in the 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 already been criticised 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. In the press the FCA was reported as stating: “We would welcome feedback on the extent to which competition will provide enough pressure to prevent a single charge resulting in an increase in charges paid by investors or other unintended consequences such as sub-optimal levels of trading or changes to market practices.” 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 as one would expect that during the consultation period the industry will conduct an intense period of lobbying in order to prevent some of the more harsher proposals from becoming a reality.
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