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John Greenwood: At last…. IMA’s soft commissions stance deserves support

John Greenwood MM blog

Fund managers have for years been misleading consumers about how much they charge for their services, that much is now clear. For decades fund managers have been hiding parts of their costs outside the AMC by paying their own research expenses through soft commissions.

Now we have finally found out what has been going on, the Investment Management Association is going to try to get its members to come clean. Its recent paper Use Of Dealing Commission: Corporate Access/Research targets corporate access initially, but also refers to a desire to clean up using soft commissions to pay for research later this year.

The IMA may have only decided to take this principled stand in direct response to media accusations of foul play, but that does not mean the initiative, spearheaded by the organisation’s institutional director Guy Sears, does not deserve the industry’s full support.

Just to recap, here is what has been going on. When fund manager buys some shares it has two options – either buy the shares on a bare execution-only basis, in which case the broker commission will be perhaps 6.6 basis points, or buy it with ‘research bundled in’ for, say 13 basis points. Opt for the latter and the broker, usually an investment bank, will put half the broking cost into a pot for the fund manager to spend on research at a later date.

The true extent of the scam is revealed by the fact that the research paid for through this way, out of the client’s money not the fund manager’s, doesn’t even go towards research on the stock bought. Its not even paid to the broker it bought the shares through. Instead, the broker keeps putting these soft commissions into the fund manager’s pot and at the end of the year the fund manager’s investment team decide which research house they want the money to go to. Talk about perverse incentives.

It now transpires fund managers are using the same pot to pay for corporate access, which means paying for meetings with senior management. The FSA reckons 29 per cent of dealing commission goes towards paying for corporate access. The IMA says its members report the figure being nearer to single figures. But whatever the actual figure, the point is that both corporate access and research should be disclosed within the AMC.

In researching this story I had hoped fund managers who do most of their research in house would be prepared to break ranks and say this practice is wrong. Surely a fund manager who trades more cheaply than one who is racking up research costs should, all things being equal, perform better and be better value. But it appears all active fund managers are paying for research off balance sheet through soft commissions.

Worse still, they will not disclose how much of their clients’ money they are spending in this way. Artemis, Fidelity, Invesco Perpetual, M&G and Schroders have all turned down requests for information on how much of their clients’ money they spend on research. Of the six managers in my straw poll only Standard Life Investments was prepared to come clean, saying about half of the broker costs on its GARS fund went to pay for research.

Let’s just think about what these stonewalling fund managers are actually saying. They are paying costs that most people think come out of the AMC, out of their clients funds. And they are not even prepared to tell the people whose money they are spending exactly how much of it they are spending.

It is hard to believe there is even a debate to be had about this. The FSA needs to change its rules quickly.

The IMA is in a difficult position, not least because transparency will cost some of its members a lot of money. But it knows that because this practice is now out in the open it will remain a cloud over the industry until it has been resolved. And with the OFT looking at pension charges, it surely needs to get its house in order.

John Greenwood is editor of Corporate Adviser

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