Warped reflection: FCA sharpens focus on marketing of closet trackers

The FCA has been criticised for not releasing the names of the fund managers involved in its investigation into closet trackers, as investment experts demand more transparency.

The FCA revealed on Monday that asset managers have paid back £34m in compensation to investors who were overcharged while using closet tracker funds.

The regulator has ordered 64 of the 84 potential closet tracker funds it examined to change their marketing. According to reports, the FCA is considering enforcement action against one fund manager over potentially misleading marketing material.

The compensation was not part of any official redress scheme from the regulator, but experts predict there will be further fallout from increased regulatory scrutiny of closet tracker funds, calling the payout so far a “drop in the ocean”.

Scrutiny from all sides

The FCA’s confirmation of compensation follows the publication of its asset management market study report in 2016, which found that approximately £109bn of investor money was sitting in so-called closet tracker funds.

These funds charge an active fee but behave like a passive fund by mirroring a benchmark or index. Writing in the Sunday Telegraph last weekend on this issue, Megan Butler, the FCA’s executive director of supervision for wholesale and specialist investment, also drew attention to “closet constrained” funds. These make active calls but are restricted around a benchmark.

FCA chief attacks managers keeping £100bn in ‘partially active’ funds

European watchdogs are also cracking down on closet tracker funds. The European Securities and Markets Authority announced in November it is collecting data on these funds as part of a review of fund fees and performance that will be published later this year.

In 2016, Esma found that up to a sixth of actively managed equity funds sold on the continent were potential closet trackers and asked national regulators to investigate further. However, only regulators in Norway, Germany and Sweden have taken direct action.

Adviser view Lee Robertson

Lee Robertson, chief executive, Investment Quorum

This will come as unwelcome news for many firms in the active fund management space as they continue to see outflows to passive fund management groups but, as fund selectors, we broadly welcome the focus on those who have been charging investors for active management but have been operating as closet trackers and just hugging benchmarks. It should be a given that investors have the right to accurate marketing material and an investment approach that is actually seeking to find alpha – it should not have taken the regulator to bring this about.

The FCA says the customers involved in its recent investigation have been paid back. However, the move to reimburse clients has not been directly dictated by the FCA. The regulator could not confirm the number of clients refunded or the method of calculating the total amount investors were paid back.

An FCA spokesman says it will add a page on its website in the coming days and provide a breakdown of the 84 potential closet tracker funds. The regulator says the web page will briefly explain what closet trackers are and the next steps it will take to address the issue.

Despite these pledges from the regulator, investment experts are concerned there is not yet enough transparency for investors to be able to make informed decisions about whether or not to put their money into these funds.

Compensation bill hits asset managers after FCA closet tracker review

Financial Inclusion Centre director Mick McAteer says the FCA investigation around closet trackers came about because of pressure on the industry.

He says: “These things take a long time to investigate. The FCA has to analyse the portfolios, including naming and shaming funds, and in this way it tells people to make their own mind [up when picking funds]. People should be given information so they can make their own decisions.”

Lang Cat consulting director Mike Barrett says the information released so far by the FCA is unhelpful for advisers whose clients might be aware of the issues, because the fund managers have not been named.

The regulator faced similar criticism recently over the pace at which it released the names of the firms that had stopped advising on pension transfers as part of the British Steel pension saga.

Barrett says: “[This investigation] seems to be a good start in that the final first set of remedies from the FCA’s report into the asset management industry is due later this month.”

However, he adds: “The FCA needs to be transparent on who it is speaking about and who is involved.”

Barrett says the £34m figure is a “drop in the ocean” when compared to how much is invested in closet tracker funds. He says: “The interim asset management market study said there was £109bn in closet trackers, but if you add an annual management charge of above 1 per cent for them, as [the FCA] previously said in the interim report, those funds have generated much more revenue than that.

A source close to the regulator adds: “This is just the tip of the iceberg and it’s hard to prove. There’s a lot more to come.”

Sound investments?

Other commentators were clear that closet trackers are not bad investments – it was the marketing of the funds that has led to the compensation payouts.
Hargreaves Lansdown senior analyst Laith Khalaf says: “There is no regulation that says you are entitled to a reimbursement if you invest in a closet tracker. These companies have been caught out for not presenting their funds accurately enough. It is good the FCA is making sure firms present funds and the constraints on them.”

However, Khalaf questions if the FCA is fully addressing the issue, pointing out that a lot of the money in closet trackers has been in the industry for more than 20 years.

He says: “The challenge is to get these investors engaged in their inv­estments and maybe switch to a better valued alternative. The big question is how you encourage people to engage in their choices so you don’t get caught up in these funds.”

Adviser viewGill-Cardy-700x450.jpg

Gill Cardy, director, Women’s Wealth

If the active management industry genuinely believes in active management, and it clearly does, it needs to behave like active managers. It’s claiming to be active, charging fees on the marketing premise you have active fund selection, then if it’s really a closet tracker that’s disingenuous. A number of funds are sold by advisers so they do have a responsibility. If you are getting a closet tracker and getting the client to pay extra money then you should go out and find something truly active or use a tracker.

Orbis Investments director Dan Brocklebank says: “We welcome this action from the FCA. It is good that it is making efforts to force managers to be clear and not misleading.

“It gives us more conviction that the industry is going to split and that active managers must either prove their worth or go full passive.”

He adds: “We believe clients should pay for the alpha they get…The investigation also shows we are willing to be accountable for what we do and align our interest with the long-term interests of your clients. If others had done that this wouldn’t have happened.”

Chelsea Financial Services managing director Darius McDermott says: “Funds that are passive-like in their behaviour should not be charging active fees, in my opinion. If a company has been misleading in its marketing about how a fund is managed then there should be redress.”

He adds: “That said, if a company has not been misleading, there is an onus on the investor to look closely at a fund before investing and decide if it is what they want – there are plenty to choose from, after all.

“Even if they’re open about the way they invest, there are also a number of passive funds whose charges are very high. Perhaps these fees should also be investigated.”

Expert view 

Industry getting the wake-up call it deserves

News that the FCA has fined a number of managers for charging active fees for funds that were essentially closet trackers will have come as no surprise to those who read and digested the FCA’s asset management study. The clues were clear, and at the time I commented that the industry was ripe for change and that we should look to the continent to see that regulators were getting active about active share. This week, this massive issue has now reached the UK.

The announcement that 64 funds have had to update their literature to make it clearer how they invest should be welcomed by everyone. For too long the industry has got away with delivering poor-quality product to investors at overinflated prices, and I hope this latest action from the regulator serves as a wake- up call to all fund providers that we can and must do better.

What the regulator needs to do now, and quickly, is publish full details of the funds involved and also highlight where previous marketing information has been unclear. It would also be helpful for there to be a clear explanation as to how these funds were identified and analysed. This degree of transparency will be crucial in helping all asset managers get their houses in order so that existing product can be improved and future new product can be developed accordingly.

The action this week will be forcing all fund groups to review their product range and ensure that it is fit for purpose and described appropriately. This can only be a good thing. It’s just sad that it has taken action by the regulator to force asset management companies to change their ways. Let’s hope this is the beginning of meaningful and lasting change.

Ryan Hughes is head of active portfolios at AJ Bell


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There are 2 comments at the moment, we would love to hear your opinion too.

  1. Well done FCA, perhaps this will feed an appetite for more action elsewhere.

  2. Fund FactSheets commonly include a graph showing how the performance of the fund in question compares with the sector average.

    A second graph showing how the performance of the fund compares with that of the index or with the average performance of all passive funds investing in that index would reveal the extent to which it is, in reality, nothing more than a closet tracker. Seems pretty simple to me.

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