‘Final Report’ is how the Financial Conduct Authority (FCA) labelled its wide-ranging Asset Management Market Study, released last week. In truth it is anything but final, as it sets in motion a raft of consultations to work out how key recommendations will be implemented.
These recommendations are in three main areas: value for money; transparency of charges and relative performance; and governance. They make sobering reading.
The FCA proposes to return risk-free box profits (earned on spreads when investors buy and sell out of funds) back to the fund rather than into the firm’s coffers. It wants managers to switch investors to cheaper share classes where possible. And it wants greater clarity on benchmarking.
Moreover, the FCA seeks a single, standardised all-in fee for investors, including an estimate of transaction charges (a tricky calculation that one). It also wants ‘strong governance’ to work in the interest of fund investors: ‘board structure could be reformed to mandate it to have a majority of independent members and an independent chair’.
But the active asset management industry, under threat from low-cost passive investing, might breathe a sigh of relief. ‘We agree that active asset management plays an important role in accurately pricing assets in a well-functioning market,’ the report said.
It added: ‘Active management can also affect firm behaviour by exercising shareholder rights.’
Passive fund feedback
Passive funds can also exercise shareholder rights of course.
On that subject, the FCA felt the need to explicitly deny a bias towards passive investment.
‘One point raised in the feedback, which we want to address, was a perception that our interim findings suggested that passive funds were preferable to active funds,’ the report stated. ‘This is not the case.’
Still, its comments on how much the active industry benefits actual investors do not make pretty reading. ‘There is some evidence of a negative relationship between net returns and charges,’ it said. ‘This suggests that when choosing between active funds investors paying higher prices for funds, on average, achieve worse performance.’
Perhaps worse still, the report was heavily critical of so-called closet tracker funds. ‘We continue to be concerned that more than £100 billion is in funds that appear to closely follow the market but are charging “active” prices,’ it said. However, there was scant detail on how they arrived at this figure. Digging through the documents and calls to the FCA have not yet made it any clearer, but watch this space.
The FCA added there was weak price competition in some areas, fund price clustering and high profit margins. Average margins were 36% for asset management firms sampled, and that excludes employees’ share in the profits of the firm through wages and bonuses.
But perhaps we should be wary of coming down too heavily on the asset management industry. The report highlighted the need for fund managers to present their products in a way that investors with limited financial knowledge can understand. It said, for example, a ‘significant number’ of retail investors are not even aware they pay charges for fund management services (see chart below for details).
Many respondents to the FCA’s interim report of November last year said retail investors had a low level of financial literacy and limited understanding of investment products. They also thought the interim report insufficiently addressed the issue of financial education.
Last week’s report said: ‘Most respondents suggested that, as financial education is not the direct responsibility of the asset management sector, we should be working with the government and the wider financial services industry on this.’
We say amen to that.
The report added that the issues of costs and charges, and of benchmarks and performance, will be consulted on later this year. A working group will also be established to convene on objectives and possible rule changes.
The industry has its work cut out to satisfy the regulator, face off the structural threat of passive funds and demonstrate the value of active fund management.
It must prove itself worthy of the challenge.