As anyone who follows this blog or any of our social media channels knows, last Friday was a momentous day for financial regulation in the UK.
That was the day when the Financial Conduct Authority finally published its long-awaited report on the asset management industry.
The report concluded that fund charges are often too high, that there is a lack of genuine competition on price and that investors are not being given a clear picture of how much they are paying to invest.
Announcing its publication, Andrew Bailey, the FCA’s chief executive said: “We want to see greater transparency so that investors can be clear about what they are paying and the impact charges have on returns.”
Although this is only an interim report — the final report isn’t expected until the second quarter of 2017 — it’s being seen as a major victory for all of us who’ve been campaigning, over many years, for clearer charges and a better deal for consumers.
What does the report say?
The 200-page report is very wide-ranging, and several different parties are criticised, including financial advisers, consultants, governance committees and fund trustees.
Specifically about fund management the reports says this:
- Because price competition for actively managed funds is limited, investors often pay high charges, and yet in most cases the returns they receive do not justify the premium they are paying
- Although there is more competition for passively managed funds, some passive funds are also providing poor value for money
- There is significant evidence of “price clustering” — In other words, fund houses charging very similar fees for their products
- Fund managers often fail to state their objectives clearly and their performance is sometimes judged against an unsuitable benchmark
- Investment consultants are generally unable to identify those fund managers who will outperform in the future
- Fund management companies have enjoyed consistently high-profit margins of nearly 40% for a number of years
- Although assets under management have grown considerably, there is no evidence that economies of scale are passed on to consumers
What proposals does the report make?
The report proposes several changes, of which these are the two most important:
- There should be a bigger onus on fund management companies to ensure and demonstrate that they provide “value for money”. This would involve an overhaul of the current system of oversight boards. Boards would be required, “as a minimum”, to take into account all fees incurred by investors, including transaction costs, to consider alternative fee structures, and to publish an annual report detailing what they are doing to ensure value for money for the customer.
- There should also be an “all-in fee” for investment funds, taking in all the different fees and charges, to improve transparency and competition among asset managers.
What has the reaction been?
The FCA has often been criticised in the past for being too light-touch in its approach to regulation and too lenient with firms who break the either letter or the spirit of the rules. Many commentators had been expecting the industry to escape with little more than a wrap on the knuckles. In the event, the general reaction has been one of surprise that the report was so hard-hitting.
Andy Agathangelou, founding chair of the Transparency Task Force, said: “(This) could become a watershed moment in the history of financial services regulation. The people who are there to protect the consumer are now serious about doing exactly that.
“Almost everybody will be a beneficiary of the FCA’s work and those that might lose out deserve to do so. ‘Sunlight is the best disinfectant’ and the FCA are blowing away the clouds. Hooray for that!”
Gina and Alan Miller of the True and Fair Campaign said: “The FCA’s comprehensive and well-founded analysis has exposed the lack of price competition in active funds, the ‘hidden’ transaction costs, such as dealing charges, that can add 0.5 percentage points to a fund’s annual charge, and the £109 billion of money languishing in ‘closet tracker’ funds, which behave like trackers but charge the higher fees associated with actively managed funds.”
There has, by contrast, been a muted response from the fund industry itself. Chris Cummings, the chief executive of The Investment Association, said: “We will engage closely with the FCA to understand its findings and the full implications of potential remedies and we are pleased that the FCA has recognised that we are improving cost transparency by developing a new disclosure code.”
What does this mean for the active vs passive debate?
While stopping short of specifically recommending passively managed funds, the FCA report makes it very plain that, at present, the returns provided by actively managed funds rarely justify the costs involved.
The report estimated that, over 20 years, a £20,000 investment in a passively managed fund tracking the FTSE All-Share index could yield a return 44% larger than that of an actively managed equivalent.
It is widely expected therefore that the report will result in outflows from active funds to passive ones.
Justin Bates, an analyst at Liberum, the stockbroker, told the FT: “The FCA clearly wants to drive the market more towards cheaper, passive investing. No question about it. The evidence it provides of the benefits of passive investment will make a lot of active manager chief executives very nervous.”
Fund houses may of course respond to the report by reducing the cost of active management. But cost reductions will need to be fairly dramatic to make active funds truly competitive with passive funds, the cost of which has fallen steeply over the last few years.
What happens now?
Again, this is only an interim report, and the FCA’s proposals are not yet definite plans. The fund industry is expected to lobby hard to have the proposals dropped or at least watered down. The Investment Association has already stated, in response to the report, that it believes an all-in fee isn’t justified.
The FCA is now consulting on its proposals. If you’d like to make a comment, you should send it to firstname.lastname@example.org by 20 February 2017. The FCA is expected to publish its final report by the end of June 2017.
You can read the full report here: