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Expert comment on FCA asset management market study interim report

Commenting on today’s FCA Asset Management Market Study interim report, David Morrey, partner at Grant Thornton UK LLP, said:

“The Financial Conduct Authority’s (‘FCA’) Asset Management Market Study Interim Report (MS15/2.2) paints an unflattering picture of the industry. It describes a retail funds’ market in which active funds cost more than passive alternatives, but do not outperform their benchmarks. In many cases they suggest that is because they are tracking closely to benchmark in a manner more consistent with passive funds. Whilst passive funds have got steadily less expensive, active fund costs have stayed largely unchanged over the past decade. It also describes asset managers as being poor at controlling some costs and poor at passing on economies of scale to investors. It also singles out fund governance boards as ineffective in representing the interests of investors to achieve value for money. Meanwhile funds are being sold on past performance (which they argue is a poor indicator of future performance) and without a clear disclosure of actual investment strategy and likely costs after dealing charges. Indeed the FCA define value for money for retail investors as “risk adjusted net returns”, and conclude that fund disclosures do not effectively communicate this definition of value to investors, whilst asset managers themselves are not evaluating whether they are delivering that definition of value to their customers.

“All of these findings are made in the context of a sector which the FCA describes as making consistently substantial profits.

“Institutional investors do have it better, although the FCA questions the role of the investment consultancies where they feel there is a lot of influence concentrated in a small number of firms with potential conflicts of interest present – the FCA is consulting on referring that sector to the Competition and Markets Authority.

“The industry will no doubt wish to comment on these conclusion. The use of different data sets, in particular the extrapolation of cost and profitability from a sample of 16 firms (out of 1,840 authorised asset managers), is sure to be part of the response. There are also obvious issues with an implicit assumption that historic underperformance is an indicator of future performance, and investors need more help to identify it, whilst historic overperformance is not an indicator of future performance and it should not be emphasised when making sales to investors.

“Beyond the analysis, however, the recommendations the FCA makes, and which it is asking for feedback on, are not revolutionary:

  • They are asking for managers to do a better job of assessing value for money for investors, which is not a new idea. They are looking at making that a more explicit duty than it currently is, but most regulated firms should understand at this point that achieving ‘fair customer outcomes’ has a value for money dimension.
  • They are considering more independence and better challenge from fund boards (including pulling them into the Senior Managers Regime). This is simply asking those boards to do their existing job more effectively.
  • They are considering introducing an ‘all in’ cost disclosure, they term it the Ongoing Charges Figure, or OCF. Also improved disclosure of investment strategy and applicable benchmarks / expected tracking error. These particular recommendations will need significant amounts of further consultation to clarify. We believe the FCA end game is not necessarily to drive fund costs down overall but rather to have greater price discrimination between funds with different strategies. That potentially will make life very difficult for active funds which are actually ‘closet index trackers’.
  • Making it easier for managers to move legacy investors into cheaper funds – the current process requires investor consent which can be hard to get.

“On their face none of these changes will be revolutionary, and should leave the industry with scope to adapt. One significant area of concern, however, is likely to be how some of these measures will go beyond the rules of other jurisdictions. If funds from those jurisdictions are being made available in the UK will domestic managers be at a disadvantage? Also of interest, some of the enhanced fund disclosure proposals are really only plausible in a Brexit scenario, where the UK can take a different path from EU rules such as UCITS. To that extent this market study can be seen as the first FCA consultation where the solutions they are discussing are not constrained by the EU regulatory apparatus.”