The UK financial regulator’s landmark report into the asset management sector in 2017 sent a scathing message: fund fees are too high and investment companies fail to give good value to investors.
Nearly two years on, fund groups have a chance to prove the Financial Conduct Authority wrong — and repair their tattered reputation.
This September, rules that clarify companies’ duties to investors come into force. UK asset managers will have to make an annual assessment of whether fund fees are justified.
Directors who sit on fund boards will be required to measure the value funds deliver and explain any improvements they intend to make.
The public nature of the reporting — boards must publish their process and conclusions — is new for UK fund managers, who have been criticised for being opaque about the reasons behind their charging structures.
The rule changes are a watershed moment, taking the UK industry a step closer to the US system, where fund boards hold investment managers to account on pricing and ensure they act in investors’ best interests.
What is more, managers will no longer be able to appoint boards comprised of “yes men and women” employed by the same group. Under governance rules that come into effect at the same time, at least two directors, or a quarter of the fund board, must be independent.
These independents are set to challenge accepted wisdom at fund companies in much the same the way as investment trust boards do. Last year, an acrimonious spat broke out between Invesco Perpetual and one of its investment trusts about fees, which led to the Henley-based fund house resigning before being reinstated.
The reporting is expected to weed out poor practice in asset management by forcing asset managers to cull high-fee, low-performing products and ensure their fund range is structured in a way that treats investors fairly.
Tony Hanlon, director at EY’s wealth and asset management division, says: “Subject to this scrutiny, it will be difficult for firms to deliver mediocre performance and charge high prices.”
One product likely to be called out in value assessments are so-called closet tracker funds, where groups charge active management fees for merely mimicking the performance of an index. In 2017, the FCA estimated that £109bn was invested in “expensive funds that closely mirror the performance of the market and are considerably more expensive than passive funds”.
Mr Hanlon says asset managers are already “housekeeping” ahead of the start of the value-reporting cycle. He says: “What we’re seeing is that firms are using the exercise as way of looking at their whole product range.”
Hugues Gillibert, chief executive officer of Fitz Partners, a fee-research specialist, says many fund groups have carried out internal value assessments for years. “It has never made much commercial sense for an asset manager […] to keep a dog on their books [so] past reviews would have certainly helped cleanse their product range.”
Mr Gillibert says the new FCA rules will force asset managers to establish “a more detailed and structured” review process using a robust methodology.
This will require time and resources: the FCA has set out seven value-assessment criteria that boards need to consider. These include performance, costs and comparable market rates as well as qualitative factors such as quality of service.
The framework was inspired by the so-called 15(c) reporting regime in the US (named after part of the American Investment Company Act 1940) under which board directors have to conduct annual audits of funds to decide whether to renew an investment adviser’s contract.
Philip Warland, a governance expert who advises UK Fund Boards, says that 15(c) reports can reach encyclopedic proportions, underlining the cost and effort that UK asset managers face. He expects most groups to employ external data providers as they establish processes for evaluating the criteria.
The task will be far from straightforward. Groups face a challenge in constructing comparative peer groups and ensuring data are robust. They may also find it tricky to access comprehensive information on market rates, for example, due to competition law.
By far the biggest issue will be providing a definition of an acceptable level of value. Beyond stating the seven criteria, the FCA has issued little guidance and will allow fund groups to approach value as they see fit.
Andrew Strange, director at the professional services firm PwC, says some asset managers are “going back to basics”, defining what value means to them and how it fits with their culture, before establishing their assessment framework.
As a result, the value reports are unlikely to be comparable at first but good practice is expected to emerge over time.
Mr Hanlon says the FCA is more concerned with ensuring that asset managers deliver on their duties and responsibilities to investors rather than measuring their costs and performance against yardsticks. “This is not about running numbers through an optimisation engine with a pass or fail figure coming out at the end: it will be slightly subjective,” he says.
In light of this, fund managers will need to ensure consistency of investment objectives across their documentation. The importance the FCA attaches to this is seen in its recent call for funds to be more open about what they intend to achieve and which performance benchmarks they use.
For example, a fund may be able to justify charging fees for a period of underperformance if one of its objectives is to deliver low volatility, says Devin McCune, vice-president of fiduciary and compliance servicesat Broadridge.
Mr McCune says the FCA’s focus on ensuring all investors are treated fairly will put managers under pressure to end the practice of letting some investors languish in more expensive share classes.
According to Fitz Partners, as many as one in three investors hold share classes incorporating commissions. A rule change in 2013 meant most investment funds could no longer charge such commissions but many investors remain in the legacy classes.
Sceptical observers worry that the leeway given to managers to define value will allow poor performance to remain hidden. Others warn it could become a tick-box exercise.
Mr Warland, though, says independent directors will help ensure managers take value seriously. Groups know they have to work constructively with independent board members in order to minimise the likelihood of antagonism.
In addition, fund board chairs will be on the hook for the value assessments after the FCA made them responsible for the task under the UK’s senior manager’s regime, which is aimed at increasing senior people’s personal accountability.
Mr Gillibert adds that the reporting regime represents a commercial opportunity for asset managers to differentiate themselves and “to grow public trust in their industry”.
Yet the rules may raise some asset managers’ hackles over a perception that the added burden damages UK competitiveness as the country leaves the EU. Mr Warland notes that small managers will feel the strain more than large groups, which will be able to optimise time and resources by creating templates applicable to multiple funds.
Mr Strange, however, says some investment groups see the regime as giving them an edge over EU counterparts and are considering carrying out the assessments for non-UK funds too.
