Under the Microscope
12 July 2017
The Financial Conduct Authority’s study of the asset management industry revealed issues around pricing and transparency, and uncovered cracks in some managers’ methodologies. Stephanie Palmer explores the findings
Image: Shutterstock
While the UK’s asset management industry has been rocked by European regulations and referendums alike, the Financial Conduct Authority (FCA) has been beavering away on other internal matters, finally producing the much-anticipated final report of its Asset Management Market Study.
According to the FCA, the UK asset management industry is the second largest in the world, with around £6.9 trillion in AuM, £3 trillion of which is managed on behalf of UK pension funds and other institutional investors.
The FCA first launched its market study in November 2015. A year later an interim report was published, revealing some of the regulator’s findings and inviting consultation, which ultimately informed the final study.
The report highlighted four main areas of concern: price competition, fund performance, clarity of objectives and charges, and the investment consultant market.
Through its findings, the FCA suggested that asset management firms do not generally compete on price, particularly when it comes to retail active management services. It also noted that, for regards to segregated mandates sold to large institutional investors, prices tend to fall as the mandate increases.
This is not, however, the case for retail funds of a similar size.
Some firms are seeing a high level of profitability, with average profit margins of 36 percent.
The report said: “Firms’ own evidence to us also suggested they do not typically lower prices to win new business. These factors combined indicate that price competition is not working as effectively as it could be.”
According to the FCA, the overall ‘package of remedies’ it proposes is intended to help make competition work better in the market and to protect investors.
The report also stated that, not only is there no relationship between the price of a fund and its performance in generating returns, but that “there is some evidence of a negative relationship between net returns and charges”.
It can be difficult for investors to identify outperforming funds, the report said, partly because it is difficult to interpret and compare past performance information. Even if they could compare this information, this is not necessarily a good indicator of future performance.
The report said: “There is little evidence of persistence in outperformance in academic literature, and where performance persistence has been identified, it is persistently poor performance.”
Equally, fund performance is not always reported against an appropriate benchmark.
In order to drive more competitive pressure, the FCA proposed measures to support disclosure of an all-in fee to investors, and to support “consistent and standardised disclosure of costs and charges to institutional investors”.
However, commenting on the report, Stewart Bevan, product manager at KAS BANK, suggested that this only addresses part of the issue.
“While it’s encouraging to see the regulator recognise the importance of transparency, now is the time for action,” he said.
“Institutional investors need the tools to help them understand the charges they pay for investment management services, and while costs are, of course, not inherently bad, understanding them is the first step toward more effective management.”
Bevan continued: “Furthermore, the decision to disclose a single all-in fee to investors is a positive step toward simplifying charges for investors, but only if it comes with clear communication that, from a scheme perspective, this is only part of the picture, and there will be other outlays that form a part of their overall expenditure.”
“Simplification is helpful, but the underlying detail needs to also be available, if required.”
Graham Vidler, director of external affairs at the Pensions and Lifetime Savings Association (PLSA) said the report makes “important recommendations”, adding: “Institutional investors, however large and however well-governed, need a competitive, transparent market in order to deliver the best outcomes for their members.”
The report also raised concerns around “how asset managers communicate their objectives to clients”, suggesting that many active funds are offering similar exposure to passive funds, but charging significantly more. In fact, the report estimated that there is around £109 billion in active funds that closely mirror the market, but are significantly more expensive than passive funds.
The FCA holds the view that value for money in asset management products comes from “some form of risk-adjusted net return”.
It said: “This can be broken down into performance achieved, the risk taken on to achieve it and the price paid for the investment management services.”
Although the report conceded that many institutional investors are increasingly focused on charges, investors’ awareness of, and focus on, charges is often “mixed and poor”.
The FCA suggested that it will chair a new working group to consider how these objectives can be made clearer and more useful to investors, particularly looking into improving the language of the objectives, before it considers making any rule changes.
Finally, the report raised concerns about the way the investment consultant market operates, noting that, while large institutional investors are able to negotiate and get better value for money, the smaller institutional investors such as pension funds find it harder to negotiate, and typically rely on an investment consultant.
It said: “We have identified concerns in the investment consulting market. These include the relatively high and stable market shares for the three largest providers, a weak demand side, relatively low switching levels and conflicts of interest.”
In response to this, the FCA said it will recommend to the Treasury that investment consultants are brought “into the regulatory perimeter”, however, this is subject to the outcome of a provisional market investigation reference to the Competition and Markets Authority.
Commenting on the report, David Vafai, CEO of bfinance, said: “We share the FCA’s central concerns regarding investment consultants in the UK institutional sector: the high and stable market shares for the three largest providers; relatively low switching levels; and conflicts of interest, particularly those that arise from offering both advice and fiduciary management.”
He added: “The lines have clearly become blurred and greater regulatory scrutiny is appropriate.”
However, the wider regulatory burden remained front-of-mind for both the FCA and industry commentators. The report noted that any remedies proposed have been considered within a wider regulatory context, particularly taking into account the second Markets in Financial Instruments Directive (MiFID II), the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation, and the Senior Managers and Certification Regime (SM&CR).
The FCA’s package of remedies is intended to support and complement these regulatory initiatives, rather than oppose or over-ride them.
“Where we believe that forthcoming regulations will at least partly address our concerns, we are looking at ways in which we can complement these changes,” the report said.
PJ Di Giammarino, CEO of JWG, did not see the proposed changes in this light, however, saying the UK’s asset management industry can “expect both new regulatory initiatives and a wide spectrum of changes to existing ones”.
He said: “This will not be welcome news to a sector that is currently resisting the reforms already asked of it.”
Di Giammarino warned that the buy side is “lagging far behind” in its implementation of MiFID II, and suggested that, with the FCA’s new recommendations, boards should start to take better notice of their regulatory obligations.
He said: “The consultation papers are out there and the handwriting is on the wall—consumers will be given more transparency, benchmarks will be more effective and managers will be made more accountable in a more competitive market. Those that start adapting to the new reality now will have a far greater chance of survival.”
However, John Dowdall, managing director of Silverfinch, noted that when it comes to fees requirements, specifically, the new remedies alongside existing regulatory requirements may lead to a surplus of data that asset managers could find difficult to manage.
Dowdall said: “MiFID II already requires a monumental amount of data to be held and communicated across different parties regarding both funds and individual investors and, if mishandled, could pose a wealth of risks along the regulatory chain.”
“Today’s report from the FCA, which concentrates on the need for an ‘all-in’ fee for end investors, will require even more data assessment for asset managers when selling a product.”
He continued: “With such large volumes of information being required, both sensitive and public, it is essential that asset managers and distributors fully prepare to meet these new rules and can assure investors that all information is protected.”
“We are thrilled by the increasing interest from the industry as it readies itself for the new regulation, but want to ensure that the focus isn’t simply on complying with the new rules, but complying in a safe and secure environment.”
The FCA is not making any rash changes, for now. Another consultation paper has already been published, asking for feedback on remedies regarding governance and technical changes to promote fairness for investors, and some of the proposed measures remain subject to the outcome of working groups.
Other recommendations will be consulted on later in the year, in light of other legislative changes, and even those that are final will be rolled out over several stages of implementation.
Andrew Bailey, chief executive of the FCA, commented when the report was released: “We need a competitive sector, attracting investment into the UK which also works well for the people who rely on it for their financial wellbeing.”
He added: “We have put together a comprehensive package of reforms that will make competition work better and help both retail and institutional investors to make their money work well for them.”
According to the FCA, the UK asset management industry is the second largest in the world, with around £6.9 trillion in AuM, £3 trillion of which is managed on behalf of UK pension funds and other institutional investors.
The FCA first launched its market study in November 2015. A year later an interim report was published, revealing some of the regulator’s findings and inviting consultation, which ultimately informed the final study.
The report highlighted four main areas of concern: price competition, fund performance, clarity of objectives and charges, and the investment consultant market.
Through its findings, the FCA suggested that asset management firms do not generally compete on price, particularly when it comes to retail active management services. It also noted that, for regards to segregated mandates sold to large institutional investors, prices tend to fall as the mandate increases.
This is not, however, the case for retail funds of a similar size.
Some firms are seeing a high level of profitability, with average profit margins of 36 percent.
The report said: “Firms’ own evidence to us also suggested they do not typically lower prices to win new business. These factors combined indicate that price competition is not working as effectively as it could be.”
According to the FCA, the overall ‘package of remedies’ it proposes is intended to help make competition work better in the market and to protect investors.
The report also stated that, not only is there no relationship between the price of a fund and its performance in generating returns, but that “there is some evidence of a negative relationship between net returns and charges”.
It can be difficult for investors to identify outperforming funds, the report said, partly because it is difficult to interpret and compare past performance information. Even if they could compare this information, this is not necessarily a good indicator of future performance.
The report said: “There is little evidence of persistence in outperformance in academic literature, and where performance persistence has been identified, it is persistently poor performance.”
Equally, fund performance is not always reported against an appropriate benchmark.
In order to drive more competitive pressure, the FCA proposed measures to support disclosure of an all-in fee to investors, and to support “consistent and standardised disclosure of costs and charges to institutional investors”.
However, commenting on the report, Stewart Bevan, product manager at KAS BANK, suggested that this only addresses part of the issue.
“While it’s encouraging to see the regulator recognise the importance of transparency, now is the time for action,” he said.
“Institutional investors need the tools to help them understand the charges they pay for investment management services, and while costs are, of course, not inherently bad, understanding them is the first step toward more effective management.”
Bevan continued: “Furthermore, the decision to disclose a single all-in fee to investors is a positive step toward simplifying charges for investors, but only if it comes with clear communication that, from a scheme perspective, this is only part of the picture, and there will be other outlays that form a part of their overall expenditure.”
“Simplification is helpful, but the underlying detail needs to also be available, if required.”
Graham Vidler, director of external affairs at the Pensions and Lifetime Savings Association (PLSA) said the report makes “important recommendations”, adding: “Institutional investors, however large and however well-governed, need a competitive, transparent market in order to deliver the best outcomes for their members.”
The report also raised concerns around “how asset managers communicate their objectives to clients”, suggesting that many active funds are offering similar exposure to passive funds, but charging significantly more. In fact, the report estimated that there is around £109 billion in active funds that closely mirror the market, but are significantly more expensive than passive funds.
The FCA holds the view that value for money in asset management products comes from “some form of risk-adjusted net return”.
It said: “This can be broken down into performance achieved, the risk taken on to achieve it and the price paid for the investment management services.”
Although the report conceded that many institutional investors are increasingly focused on charges, investors’ awareness of, and focus on, charges is often “mixed and poor”.
The FCA suggested that it will chair a new working group to consider how these objectives can be made clearer and more useful to investors, particularly looking into improving the language of the objectives, before it considers making any rule changes.
Finally, the report raised concerns about the way the investment consultant market operates, noting that, while large institutional investors are able to negotiate and get better value for money, the smaller institutional investors such as pension funds find it harder to negotiate, and typically rely on an investment consultant.
It said: “We have identified concerns in the investment consulting market. These include the relatively high and stable market shares for the three largest providers, a weak demand side, relatively low switching levels and conflicts of interest.”
In response to this, the FCA said it will recommend to the Treasury that investment consultants are brought “into the regulatory perimeter”, however, this is subject to the outcome of a provisional market investigation reference to the Competition and Markets Authority.
Commenting on the report, David Vafai, CEO of bfinance, said: “We share the FCA’s central concerns regarding investment consultants in the UK institutional sector: the high and stable market shares for the three largest providers; relatively low switching levels; and conflicts of interest, particularly those that arise from offering both advice and fiduciary management.”
He added: “The lines have clearly become blurred and greater regulatory scrutiny is appropriate.”
However, the wider regulatory burden remained front-of-mind for both the FCA and industry commentators. The report noted that any remedies proposed have been considered within a wider regulatory context, particularly taking into account the second Markets in Financial Instruments Directive (MiFID II), the Packaged Retail and Insurance-based Investment Products (PRIIPs) Regulation, and the Senior Managers and Certification Regime (SM&CR).
The FCA’s package of remedies is intended to support and complement these regulatory initiatives, rather than oppose or over-ride them.
“Where we believe that forthcoming regulations will at least partly address our concerns, we are looking at ways in which we can complement these changes,” the report said.
PJ Di Giammarino, CEO of JWG, did not see the proposed changes in this light, however, saying the UK’s asset management industry can “expect both new regulatory initiatives and a wide spectrum of changes to existing ones”.
He said: “This will not be welcome news to a sector that is currently resisting the reforms already asked of it.”
Di Giammarino warned that the buy side is “lagging far behind” in its implementation of MiFID II, and suggested that, with the FCA’s new recommendations, boards should start to take better notice of their regulatory obligations.
He said: “The consultation papers are out there and the handwriting is on the wall—consumers will be given more transparency, benchmarks will be more effective and managers will be made more accountable in a more competitive market. Those that start adapting to the new reality now will have a far greater chance of survival.”
However, John Dowdall, managing director of Silverfinch, noted that when it comes to fees requirements, specifically, the new remedies alongside existing regulatory requirements may lead to a surplus of data that asset managers could find difficult to manage.
Dowdall said: “MiFID II already requires a monumental amount of data to be held and communicated across different parties regarding both funds and individual investors and, if mishandled, could pose a wealth of risks along the regulatory chain.”
“Today’s report from the FCA, which concentrates on the need for an ‘all-in’ fee for end investors, will require even more data assessment for asset managers when selling a product.”
He continued: “With such large volumes of information being required, both sensitive and public, it is essential that asset managers and distributors fully prepare to meet these new rules and can assure investors that all information is protected.”
“We are thrilled by the increasing interest from the industry as it readies itself for the new regulation, but want to ensure that the focus isn’t simply on complying with the new rules, but complying in a safe and secure environment.”
The FCA is not making any rash changes, for now. Another consultation paper has already been published, asking for feedback on remedies regarding governance and technical changes to promote fairness for investors, and some of the proposed measures remain subject to the outcome of working groups.
Other recommendations will be consulted on later in the year, in light of other legislative changes, and even those that are final will be rolled out over several stages of implementation.
Andrew Bailey, chief executive of the FCA, commented when the report was released: “We need a competitive sector, attracting investment into the UK which also works well for the people who rely on it for their financial wellbeing.”
He added: “We have put together a comprehensive package of reforms that will make competition work better and help both retail and institutional investors to make their money work well for them.”
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