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Paying the price: Funds fail to meet FCA test on AUM

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Research by Money Marketing suggests almost half of funds based in the UK are too small to be financially viable in the longer term.

Based on evidence submitted as part of its recent asset management study, the FCA estimates a fund needs to attract about £100m in assets under management to be viable and cover fixed running costs.

But data from Morningstar on behalf of Money Marketing shows a significant number of funds fail to reach this threshold. Of the 2,938 open-ended UK-domiciled funds in operation, 1,321 have less than £100m in AUM, equivalent to 45 per cent of the total. There are 922 funds with less than £50m and 500 funds with under £20m. Of those 500 funds, 276 have been running for over five years.

While some of these funds will simply be new to market, there are questions about whether this proliferation is justified, and whether repeated launches are the best way to hunt out returns for investors. Are fund groups failing to close funds in the hope that investors do not notice poor performance? And are clients paying the price for investing in a sub-scale fund?

Crunching the numbers

Looking across all Investment Association funds, Gbi2 managing director Graham Bentley notes the 80/20 rule holds strong. He calculates that 22 per cent of IA funds hold 80 per cent of total AUM, and more than a quarter of funds make up less than 1 per cent of industry assets.

Among multi-asset funds, he says 60 per cent hold less than £100m while across the UK All Companies and UK Equity Income sectors a third of the funds have less than £100m.

Bentley says: “It’s pretty clear there are too many funds.  This helps to explain why outstanding performance is hard to come by; there are just too many managers using the same information and research to make their selections. Mispricing is harder to spot, since the competition is so great.

“If the crowd of investment managers and other players such as discretionary fund managers continues to grow, then the mundane will become more prevalent and skill will be washed away.”

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Wealth Club investment director Ben Yearsley believes with the exception of newer funds that are less than two years old, many of the 500 funds with less than £20m in assets will be unprofitable.

He says: “There are many funds on the sub-£20m list that should have been put out of their misery years ago. For example, Manek Growth has underperformed the FTSE All Share by a whopping 79 per cent over the last 15 years.

“Baring UK Growth is another that has consistently underperformed over 15 years.

“Conversely, there are also some excellent funds highlighted: Unicorn UK Growth has just under £20m but has outperformed the FTSE All Share by 106 per cent over the same period. I am amazed investors put up with poor performance over such a long period of time. If you want to be that inert, buy a tracker.”

There are some major fund groups sitting behind these sub-£100m funds. Fidelity, for example, has 33 funds with assets of under £100m, while Aberdeen has 28 and Architas has 19.

A spokesman for Fidelity International says: “Funds can be small for a variety of reasons, for example they are relatively new or they target a specific outcome. We constantly review our product range to ensure it remains relevant to our clients.”

Architas head of UK funds Cedric Bucher says there are specific reasons why some of its funds have less than £100m. He points to the Architas Birthstar Target Date funds being relatively new, while he says the Diversified Protector funds are legacy products that are no longer being promoted.

He says: “There is a natural life-cycle for funds from launch to a growth phase and sometimes into a legacy stage. We have a continuous review process that considers first and foremost if our funds are meeting client expectations but also looks more broadly at investment performance, as well as the costs of operation.

“If appropriate, we will take action to either close or merge funds that are not meeting the needs of clients or are deemed no longer suitable for the current market.”

Aberdeen declined to comment.

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The search for winners

Hargreaves Lansdown senior analyst Laith Khalaf argues the £100m threshold highlighted by the FCA may be fairly arbitrary, given that much will depend on the fund group itself. He says a company that is running 50 funds will face smaller marginal costs when it comes to setting up a new fund, as the infrastructure is already in place. The existing processes for administration and compliance, plus the analysts and the fund manager mean the cost burden may not be so great for fund launches.

Khalaf says: “Fund groups are minded to pursue this strategy of launching a number of different funds, as long as they can get to that point where they are making some money. By launching more funds they increase the chances of having one of those big winners. Putting all their eggs in one basket opens fund groups to the risk that a sector falls out of favour. We saw that with emerging markets two years ago, and fund groups like Aberdeen were hit as a result.”

Khalaf says there is also an element of fund houses chasing “fashionable areas”, such as the spate of multi-asset funds launched after the pension freedoms.

He says: “The issue when you have a fad like that is you get a lot of fund groups opening ‘me too’ funds hoping to benefit from a trend, but it may be a part of the market that is outside their normal comfort zone.

“The money destined for those funds is then more widely spread, meaning only a few of those funds will actually achieve a decent scale.”

Former Investment Association chief executive Daniel Godfrey, now an independent consultant, says fund groups should not be criticised for launching funds where there is a strategy to grow the fund for clients.

fundsundertableBut he says judgements need to be made on whether profits made on well-performing funds outweigh the effect of small funds doing badly, and whether the cycle of fund launches is delivering value to consumers.

Godfrey says: “Clients and advisers need to ask the question on why certain funds are being kept open, and fund groups must have an answer. The structure of the smaller funds can mean the total expense ratio is very high. Compare this to the bigger funds, and if it is very different, you have to ask if it is costing more for consumers to be in a sub-scale fund.”

AJ Bell head of fund selection Ryan Hughes says investors should look past the “absolute number” on fund size and examine the direction of travel, that is, is the fund growing
or shrinking?

He says: “People also need to look at how long that fund has been small. What is the intention of the fund group promoting it? Do they have plans to change the fund or cut the fees? There is all that extra work that advisers need to do when they have clients with holdings in those funds.”

Fairer Finance managing director James Daley says there are clearly trade-offs to be made between larger, more efficient funds and smaller, more nimble ones.

He says: “In some cases there may be good reasons to keep funds small. But I’m sure there are cases where funds have diminished in size due to underperformance, and managers have kept them open because they don’t want to lose the rump of investors who remain – and perhaps who are oblivious to the fund’s underperformance.

“Fund mergers inevitably wake up sleeping investors, and may result in investors transferring their money to a different group.”

Bentley says continued pressure from the FCA may force fund groups to get to grips with the level of unviable funds in the market.

He says: “The FCA’s asset management market study is shining an intense spotlight on an industry that is ripe for consolidation if not reconstruction.  By the end of 2017, larger asset management groups may have little alternative than to slash their product ranges and cull their non-performing managers.”

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Comments

There are 4 comments at the moment, we would love to hear your opinion too.

  1. Would be interesting to know how many are sub funds white labelled for advice firms. A fair few of these were sub £100m years ago and unlikely to grow as the regulations tightened on DIFs and independence.

  2. Hmmmm. Are we now seeing the seeds being sewn for the next round of retrospective thematic reviews?
    FCA “So, Mr adviser, you failed to demonstrate how, because this fund is smaller than our assessed minimum, you failed to treat your customer fairly. Please conduct a full review of all business you did for clients in funds of less than this size and pay redress to all concerned”.

    Adviser “But all the research, due diligence and risk profile showed this fund was a spot on watch for the client PLUS it has performed very well over the last 5 years, with the client doing very nicely.”

    FCA “This fund does not meet our standard now in terms of size and so poses a systemic risk to the client that they will not be aware of because you didn’t discuss it. You failed to demonstrate you had discussed this in your SL so by definition you did not do it”.

    Adviser “So in 2107 you decided that any fund less than £100 Million is not viable and as such due to us having invested our client into this fund in 2012 you are now saying we have screwed our client”?

    FCA “By George I think he has got it”.

    Adviser “How on earth were we supposed to know this was going to occur”?

    FCA “Any half competent adviser should have recognised the fact that a fund under £100 mill posed a risk”

    Adviser “But you didn’t draw this conclusion 5 years ago”.

    FCA “It is not for us to advise your clients, that is supposed to be what you do and you clearly haven’t done your job properly”.

    Does this type of thing sound familiar to anybody?

  3. With the sheer weight of evidence now being produced from institutions such as the FCA, CPS and others outright critical of active management, its only a matter of time before the Claims Companies jump the bandwagon to generate a whole load of new claims for recommending active funds when their value has been proven to be close to worthless after fees.

  4. So in the FCA’s eyes (although they may say to the contrary) its not how the fund is used and performs……..

    Size really does matter !

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