The Financial Conduct Authority (FCA) recently published its Management Market Study Final Report, a hard-hitting document hiding behind a rather soberly named title. In November 2016, the FCA’s interim report found evidence that suggested that there was weak price competition in a number of areas of asset management, and this finding was confirmed in the final report.
Whilst these plans were not specific to the tax-advantaged world of investments, certain measures will very likely affect managers in this area – in particular, those relating to the disclosure of costs and charges.
In its final report on the Asset Management Market Study, published on 28 June 2017, the FCA confirmed some findings that are very applicable to managers in the tax-advantaged space, particularly on fees, performance, and clarity of objectives.
Of particular note to managers in this area, the FCA found that:
To address these issues, and to complement incoming regulations affecting asset managers, the FCA proposed, inter alia, to strengthen the legal duty on managers to act in their investors’ interest, change governance to include at least two independent directors on their board, and return risk-free profits and ease the process of switching investors to a cheaper share class.
The FCA has pledged to support the disclosure of a single all-in fee to investors, commissioning a group to come up with a single template for fees and charges, and convene a working group focused on making fund objectives more useful and past performance better reported.
Given the rise of low-cost passive investment and the low-return environment, as well as the generally poor returns from active fund managers, it was close to inevitable that the FCA would look to review how the asset management industry functioned for investors.
When it comes to the tax-advantaged world, we have often seen similar issues when it comes to the levels of transparency of fees, performance, and clarity of objectives.
On fees, MJ Hudson has long been an advocate of greater transparency and alignment with investors. Too many managers take fees according to ‘sector norms’ or what they deem to be appropriate, rather than based on outcomes achieved. In our view, managers are able to charge more because of the tax-advantaged nature of the products enhancing investor returns. Moreover, often managers’ charging structures are complex and opaque, even where these are technically disclosed. Economies of scale for managers are scarcely ever reflected in better value for investors in terms of fees and sundry charges. In MJ Hudson’s opinion, fees should pass a four-part test: charges should be competitively priced; where managers team up with framework partners, each party should be rewarded based on the value they add for investors; fees should be completely disclosed and transparently stated; and, ideally, the fees should align with the interests of investors in terms of outcomes, rather than simply manager output, so that risk and return is (at least partially) shared.
While the emphasis on fee standardisation and disclosure by the FCA is welcome, the proof of the effectiveness of the proposed single fees template will be in the behavioural change it seeks to effect of transparency leading to a better awareness of the link between fees and value and, therefore, more informed choices by investors. Whilst increased transparency itself is welcome, it does not automatically follow, particularly in a disintermediated market, that fees will become better aligned or that there will be greater competition overall on costs… although it stands to reason that, at least in theory, over time the market should address any misalignment in fees.
On performance, MJ Hudson awaits with interest the suggestions of the working group proposed. Data on past performance for tax-advantaged managers is often patchy and/or cherry-picked– one reason that we insist on capturing all past performance data in the MJ HudsonIQ system – although the old adage that past performance does not guarantee future returns remains as true as it ever was. Nonetheless, investors would be better served with full and clear past performance data as these would provide an objective input in the evaluation of a manager’s investment skill and value added for investors. MJ Hudson awaits any proposals to that end.
Concerning the challenges identified with respect to performance, on clarity of objectives, we have identified the issues that the FCA has highlighted are also present in the tax-advantaged world. Too often Investment Memoranda contain return targets including the consideration to the tax benefit in the illustration of the baseline returns for investors, when this is the compensation to the investors from the government for risk-taking and not intrinsic to the skill of the manager. Some managers even state that they seek less than a pound back for every pound invested, meaning that net of fees, the manager intends to lose money! Although, from an investor’s point of view, they have received the tax benefit and hence may be content. Nonetheless, as analysts of investments and investment managers, our view is that any investment objective where a manager does not target adding-value, net of their own fees, is below MJ Hudson’s minimum standards for what makes an “investable” proposition, i.e. one that investors should consider. While the FCA highlighting this issue of clarity is appropriate, MJ Hudson awaits proposals from the working group with interest to see how the proposed ultimate remedies particularly apply to the tax-advantaged space.
The FCA report is not the instigator of change, but a response to calls from investors that change was long overdue. If managers in the tax-advantaged space want to maintain the goodwill of investors without more heavy-handed intervention from above, things will need to change. They’ve been warned.
MJ Hudson’s briefing on the FCA’s interim report can be found, here.
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