The FCA launched its market study into asset management in November 2015 to look at how competition is working in the asset management industry for both retail and institutional investors.
Its interim report (MS15/2.2) was published on 22 November 2016 and presents the FCA’s interim findings. In it the FCA sets out its views on how well competition is working and the resulting outcomes for investors. It also outlines some proposed remedies.
FCA is inviting stakeholders to share their views by 20 February 2017 on issues identified and action proposed. Some in the asset management industry have been very vocal in questioning, among other things, the FCA’s methodology, data and motives; while others have offered a strong rebuttal to some of the FCA’s findings.
FCA Findings – what are the headlines?
1. Price competition is weak in the asset management sector
The FCA's key interim findings are that competitive forces are not working in the asset management sector – in particular active managed funds, where charges have remained broadly the same for the last 10 years and the FCA found little evidence that managers compete on price. Furthermore, there is considerable price clustering around the 75–100bps mark, which the FCA suggests indicates firms are generally reluctant to undercut each other.
2. Asset managers earn high profits
The headline grabbing figure is that asset managers’ margin is on average 36% which the FCA considers lavish when compared with insurers and platforms. Of the firms in the FCA’s sample, their profit remained flat or grew, while fund charges remained static, with profits being higher for retail fund management and for active strategies. However, firms and trade bodies have highlighted that the FCA sample group is relatively small (only 16 firms) and not necessarily representative of the industry as a whole.
3. No clear relationship between price and performance
FCA stress the point that active funds, for retail investors in particular, do not generally outperform their benchmarks after costs and there is no clear relationship between price and performance – the most expensive funds do not appear to perform better than other funds. It has highlighted particular issues with so called 'closer trackers' – active funds that offer similar exposure to passive funds but some of which charge significantly more.
4. Asset managers are not good at controlling certain costs
Or not always good. FCA found that asset managers tend to be good at managing charges which are straightforward and inexpensive to control (e.g. custody, administration and record keeping) but less good at controlling costs for services where it is more expensive to monitor value for money, such as how well executed trades and FX transactions are.
5. Fund governance bodies not focused on value for money
FCA found that fund governance bodies (whether in-house or outsourced) lack independence from the fund managers and do not appear to exert effective challenge on value for money. Examples given include that boards: often do not compare the asset managers fees for managing a retail fund's portfolio with the fees they charge comparable institutional clients to assess whether the difference is reasonable compared to the difference in costs; and do not typically question whether the economies of scale achieved when funds grow to a certain scale are shared with retail investors (in the same way that break points are routinely used for segregated mandates with institutional investors).
6. Investors don’t understand
FCA acknowledges that progress has been made to improve the transparency of fund charges, but it has concerns that investors do not know or understand that transaction costs will apply on top (since they are not required to be included in the OCF). This is if they even realise they are paying charges at all; the FCA found that around half of non-advised retail investors were not aware. In addition to charges, FCA still has concerns about how fund objectives are described and disclosed.
What is the FCA going to do about this?
The FCA has suggested a number of remedies in its interim report and is inviting feedback on them from the industry. The highlights are as follows:
Making further changes to the disclosure requirements is a well-trodden path for the FCA and its predecessor and, as could be predicted, forms a large part of their suggested remedies. Some of the proposed "remedies" being considered include: requiring asset managers to be clear about the objectives of the fund and report against these on an ongoing basis; clarifying and strengthening the appropriate use of benchmarks; and providing tools for investors to identify persistent underperformance.
The disclosure of an “all-in” fee (including transaction costs) is suggested, and it seems likely FCA will implement this change in one form or other although some of the proposals being considered are more radical than others. In particular, one proposal is for the inclusion of a single charge which includes all charges taken from the fund (including transaction costs) with no option for overspend. Under this model the asset manager would bear all the risk of a difference between the forecast and actual trading costs – which, perversely, may have the potential to incentivise managers to reduce transaction levels in a way that is contrary to the interests of investors. Also expect the need to illustrate the impact of charges on returns, perhaps in a similar way as the reduction in yield figure for packaged products.
Duty of care
The introduction of an enhanced duty of care on managers, implemented through changes to governance arrangements and enhanced senior management responsibility is the likely route for the FCA to follow here. This will then give the FCA a springboard by which to challenge firms on their pricing strategies, their cost control and (indirectly) their performance (by focusing on the impact of charges on the ultimate return for the investor). There is more than one way to skin a cat.
It is also notable that there are some findings outlined in the paper for which a remedy is not suggested. We expect to see more in the final report on the use of past performance in particular.
What can asset managers be doing now?
Read the interim report, but read it all the way through. The headline findings have been widely reported but the paper contains a number of more detailed findings which may impact some firms’ current practices.
FCA has noted a number of specific areas where they are unhappy with fund managers' processes and may well consider they have now given the industry their final warning. Any firms still retaining risk-free transactional box profits in dual priced funds, for example, should take note.
There are also specific concerns flagged with absolute return funds which relevant firms could be considering now – in particular where funds are charging a performance fee when returns are lower than the performance objective the fund is seeking to achieve.
The deadline for responses to the paper is 20 February 2017.
Given the significant and far ranging implications of the FCA’s findings and suggested remedies, asset managers should make sure they make their voice heard, either through the Investment Association or directly.