A year after the FCA’s critical review of the asset management industry, fund managers, platforms and advisers continue to feel under scrutiny over value for money.
The “one of a kind” report into competition between asset managers has re-opened the long-standing debate on the role of active fund management in particular.
Fears were initially raised that some UK retail-focused asset managers would be badly hit by the FCA clampdown on fees. Fund giants such as BlackRock even started to short their peers.
But we have not seen a major collapse, and investors soon dismissed some of the short-term concerns around the vulnerability of active managers.
However, commentators agree that firms have started making strategic moves in the 12 months since the review launched.
Experts reflect on the review’s fallout to see how the investment industry is adapting to a new normal.
The FCA interim report into the fund industry, published in mid-November last year, found active management fails to justify high fees for lacklustre returns.
The regulator proposed a series of reforms, including an “all-in fee” for funds, greater clarity on charges and easier switching into better-value share classes for retail investors.
As well as making a number of damning remarks about the performance of active funds after charges, the FCA also said it had “some concerns about whether intermediaries deliver value for money”.
In a follow-up final report, published this year, the regulator confirmed it would go ahead with some of the suggested measures, which it called “a comprehensive package of remedies”.
In particular the FCA focused on the role of platforms.
The Lang Cat consulting director Mike Barrett says: “Over the past months, there has been a deflecting of the problem onto platforms and magically a platform study appeared. This feels to be a gentler approach but slower paced than the asset management study, where the consultation on the remedies is moving much more rapidly.”
Law firm Dechert financial regulation partner Monica Gogna says the regulator will wait for other major events to take place such as Mifid II before releasing the result of its final review. Industry consultation closed at the end of September.
She says: “The FCA interim report was one of a kind for the asset management industry. Looking at the final report, I don’t think the FCA was less punitive than it was in the first one, as many have said. I feel the FCA has listened carefully to the problems. There is a lot of regulation coming next year, so it was sensible for the FCA to take a pause and see what the other regulations will do. The FCA will release the consultation on its remedies so we’ll see more detail in that.”
Commentators say while no dramatic changes have yet emerged in the industry, some of the “pain” has started to come through as a reaction to some of the more drastic proposals for asset managers. Among these are the disclosure of a single transparent charge and the requirement to hire independent directors to boards.
Barrett says: “On overcharging products, it is only a matter of time until firms have to start changing. Some firms have already started differentiating from what they were doing. The pain is coming though, it is going to be significant.”
As first outlined in the interim study, the FCA is looking into how fund managers and platforms can reduce investment costs and pass the benefits to customers.
In both the interim and final reports, the FCA flagged its interest in platforms securing discounts on fund charges, arguing this practice did not appear to be widespread.
The average discount on the Hargreaves Lansdown Wealth 150 list is 30 basis points, but 51 of the funds have less than a 10bps discount. A couple of funds have more than 10bps, while one fund has a 50bps discount.
Barrett says: “This actually raises the question of why all the customers are elsewhere and not in that share class and are paying 50bps more than anybody else. You start questioning if the other customers are being treated fairly.”
Adviser view: Tim Page, director, Page Russell
There are huge forces driving the asset management industry at the moment, like the rise of passives and regulations such as Mifid II, so it is early days to see any effects of the FCA review. It is going to be difficult in five or 10 years’ time to see what the review actually caused because of many other influences in the market.
Barrett notes there are 13 passive funds in the Hargreaves list, mostly from Legal & General Investment Management, that have a discount of 0.05 per cent. That means on a £20,000 investment in an Isa every year for 10 years, investors would only save £287.
He says: “There is a real danger that, if you think this discount is giving the lowest cost of investing, it isn’t. This also happens at the likes of Barclays and Santander, not just Hargreaves.
“The FCA is keen to negotiate and reduce the cost of ownership but they can’t do anything to directly influence flows, particularly on the advice side. There’s some really strict regulations on advisers and if you look at flows from advisers they’re ignoring this stuff anyway.”
Berenberg analyst Chris Turner says there is still a lack of understanding over how fund managers need to communicate their decision to move investors across to the cheapest share classes as proposed by the FCA.
He says: “What asset managers said is that if investors don’t respond to changes they may make, what is the solution then? A year on, we still don’t know if this will change.
“Some things have been changed quickly [after the FCA final review] such as the ban on box profits. The rest of the issues will take a long time.”
Turner says the role of consultants and the rise of vertical integration was the “new area” of interest from the regulator compared with many other findings, which didn’t come as much of a surprise.
The FCA called into question whether firms such as St James’s Place, Standard Life, Old Mutual Wealth and Hargreaves promote their own funds to advisers for their own interests or the end consumer’s.
Currently, the top five retail platforms, which make up over 50 per cent of the market in terms of net flows, are part of vertically integrated firms which also operate advice and/or fund management businesses.
Barnett says it is “unrealistic” to ask these firms to make it easier or cheaper to buy competitors’ products.
The FCA also questioned the high profit margins of many asset management companies, which were found to be above 36 per cent.
But respondents to the interim report pointed out some vertically integrated models have margins “in excess” of fund managers’ profits.
Liberum analyst Justin Bates questions the regulator’s focus on profit margins.
He says: “Why is a certain profit figure inappropriate? I don’t think profitability is a measure of whether there is competition in the marketplace.”
Bates argues moves to drive down profitability could be damaging, and that the business models of some players need to be taken into account.
Why has the FCA been urged to look at how advisers add to costs in the value chain?
1: Advice costs are often claimed to be one of the largest portions of the asset management value chain.
2: Concerns over conflicts of interest in vertically integrated firms.
3: Rapid growth of adviser networks.
4: Concerns over model portfolios and their potential poor value for money, poor transparency and higher tax liabilities for investors.
He says: “I don’t buy the argument on margins being too high or too low, and let’s not forget the nature of some of these companies, and this is the irony; the whole issue here on what the FCA wants is to encourage competition and what is going to happen…
“You are seeing an acceleration of consolidation in the industry because people want to maintain their profit margins, so the irony is there is a reduction in competition.”
An industry “eating itself”
The “all-in fee” suggestion, which runs along the same lines as Mifid II, has currently been put on hold. The model will require fund managers to include an estimate of trading costs in one single figure.
In the meantime, a number of fund houses, including Baillie Gifford and Fidelity International, have started to tweak their pricing structures, lowering costs or introducing new models this year in an attempt to offer some alternatives to investors.
The debate on fee models escalated this year when Fidelity proposed a new landmark performance fee model, marking the first major move from a fund house on the fee debate post-FCA review.
Borrowing from a model more popular in the US, the asset manager introduced a new variable management fee that will change depending on the fund’s performance.
Turner says there are a lot of different ways to design performance fees but even small changes to the design have massive implications. He claims just the performance fee per se doesn’t result in lower costs.
Orbis Investment director Dan Brocklebank, which also offers a performance fee, but in a different shape to Fidelity’s, says while the FCA study was “spot on” on overcharging, fees structures still need a radical reform.
He says some of the solutions raised by the FCA fix the symptoms but are not attacking the real underlying causes of the problem, which is incentives.
He says: “The ad valorem fee incentivises asset gathering and that is not a controversial statement but it leads to a massive product proliferation and ultimately it leads to closet indexing. If you want to go at the bottom of these issues you need to be prepared to do something different.
“The fee structure of all the investment industry needs to be radically reformed. The fee structure means you are going to pay the fees, regardless of what that performance ends up being.”
There’s some really strict regulations on advisers and if you look at flows from advisers they’re ignoring this stuff anyway
However, independent consultant Daniel Godfrey says the ad valorem fee is not always the wrong way to charge investors.
He says: “What the industry hasn’t got right is to pass the economy of scale to investors passing a certain point. I don’t think the ad valorem model is always wrong in all circumstances. In fact it’s still got quite a lot going for it.
“Say you’ve been paying Terry Smith 90 basis points since he launched his fund. Frankly if you’ve been paying 200 basis points you would still be happy today.”
Barrett says BlackRock was “eating itself” as a result of the regulator’s debate around fees when it decided to short its position on some of its rivals after they faced strong pushback from the FCA report.
But Brocklebank recalls star fund manger Nick Train writing to investors around six months later on why he was buying some of the asset managers across his portfolio, not selling.
At the time, Train wrote: “We think it will take an industrywide abolition of ad valorem fees to undo our expectation of contingent superior economic returns, therefore we regard the June sell-off as a buying opportunity.”