Investment management

Asset Management Market Study – Final Report

The FCA releases final report on the Asset Management industry. If you didn’t like the interim report, you won’t like the final.

David Morrey, partner and head of investment management at Grant Thornton UK LLP, commented: 

“Today’s publication by the Financial Conduct Authority (FCA) of its Asset Management Market Study (final report) holds few surprises. The regulator has shown itself to be largely impervious to the lobbying efforts of the industry, who found fault in both the analysis and conclusions of the interim report published by the FCA in late 2016. If you didn’t like the interim report, you won’t like the final report. 

“Essentially the FCA’s conclusions are the same. They are concerned that price competition in retail investment funds is poor, with the result that firms make high profits and investors do not get the benefit of scale and other efficiencies achieved by the industry. They are also concerned that there is no correlation between higher fees and better long term fund performance, the implication being that investors are not getting any additional benefit from the higher price. 

“Two notable shifts in the tone of the report in its final form, however: 

  • “It has backed away from the frontal assault it began on whether actively managed (and generally more expensive) funds could ever be a better choice than cheaper passive (index tracking) funds. The argument that passive funds are, in all market conditions, better than active funds is hard to make, and the FCA probably realised the dangers of driving investors to passive funds where managers have no discretion to avoid market train wrecks. 

  • “It has also backed away from considering whether managers should have an additional duty to spell out to investors when they are in serially underperforming funds. The general appetite to improve disclosure remains but it doesn't single out funds which fall below a theoretical, and the FCA admits, likely impossible to set fairly, performance threshold. 

“Plenty remains however. The key elements are described below. By focusing on areas such as better governance and fairer disclosure of costs and performance the FCA adopts familiar sounding solutions. The challenge is that they are also, in principle, evolutions of the solutions we already have in place. The Market Study confirms those current solutions are flawed, not driving the expected behaviours or capable of being ‘gamed’ to present misleading information. Changing these rules is desirable but we don't underestimate the difficulty, maybe the impossibility, of coming up with changes that do not themselves create some perverse incentives or allow for different games. Indeed tucked away in the industry response to the Market Study consultation, overshadowed by disagreements in headline findings, has been concern that the remedies on the table may be, if not impossible, then very hard to implement in a fair and consistent manner.” 

A summary of the main Market Study findings and additional commentary (attributable to David Morrey)

  • Expanding the general duty on fund manager to act in the best interests of investors to explicitly include consideration of the value for money those investors are achieving. 

“Whilst this only codifies what the FCA has been saying informally for some time across the whole financial services sector, we believe most fund managers are a long way from having practical measures and tools in place to actually assess value for money and a considerable amount of effort will be required to put them in place. If they choose to do so, managers may benefit from some of the work done in those sectors which have already experienced a similar challenge from the FCA, such as consumer lending.” 

  • Changing the rules so that the ‘risk free’ box profits made by some fund managers are passed onto investors.

“Box profits occur when a fund manager uses its own money to invest in its funds alongside external investors. As external investors enter or leave the fund, the manager essentially trades its investment with that external investor. It is possible for a manager to make sizeable profits by doing so. A small number of managers have enjoyed large box profits for some time and they have resisted giving them up as they are explicitly permitted under current rules. There has been some movement, for instance Jupiter has announced its intention to give up these profits. The FCA has now said they will change the rules to eliminate these profits, creating a material hole in the P&L of a few managers.” 

  • Changing the rules so that investors in old / higher cost funds (or share classes within funds) can be switched by a manager to their own lower cost funds without the burdensome and often unworkable obtaining of consents that currently exists.

“This at least is likely to be welcome. If older funds / share classes can be closed as a result both investors and managers should benefit - the former with lower charges, the latter with reduced complexity and cost.” 

  • Requiring disclosure to retail investors of a single all-in fee estimate including all the costs of holding that investment. The most significant change here is that it would include trading costs (the dealing charges the fund incurs when it buys and sells investments). Rather than being a largely invisible drag on performance it would need to be included in the fee charged to clients. 

“The detail of this requirement will have to wait on a consultation later this year. On the face of it, however, this worries the industry a lot, both in terms of how competitive (or not) it will make one firm’s fees look versus others, and also whether it will drive unintended consequences, including scenarios where a manager chooses not to incur the costs of extra trading even though market conditions may warrant it. This will be a difficult area to balance the duty to provide fee certainty to investors with the duty to act in their best interests if circumstances dictate. Ultimately the industry's concern is likely to be the level of extra judgement it will need to apply and the risk (and consequences) of having that judgement found wanting in hindsight.” 

  • Requiring managers to be more explicit about the role benchmarks / indices play in the investment strategy of a fund. This is intended to make ‘closet trackers’ easier to spot. Related rule changes will also limit the ability of managers to cherry pick different benchmarks to show past performance in the most positive light in their marketing. 

“These are likely to be largely uncontentious changes provided they are done in a manner which genuinely does limit the ability of managers to game the rules to present their performance in a deceptively positive manner. Everyone claims they want a level playing field in this area. The devil will be in the detail, however, and whether the new rules when published actually achieve their goals.” 

  • Institutional investment advisors are, with Parliament’s consent, to be bought within the FCA’s regulatory perimeter, and also subjected to a competition investigation. 

“These advisors are key players in the pension scheme industry, advising those schemes on how and with whom to invest. The market is dominated by a few large players and currently they are unregulated. As this is essentially the first time this sector will have come under scrutiny there is potential for some significant changes as the regulator closes its grip, although most of these changes will be invisible to ordinary investors.” 

  • Further work to be conducted on the role played by retail investment platforms, which today play a major role in the mechanics of how investors access the funds of the asset management industry. 

“While that work remains to be performed, the focus is inevitably going to be on whether platforms provide cost efficiencies from which investors benefit. The Market Study leaves that as an open question, but implies that the answer is no.”