In June 2017, the FCA finalised their findings on the Asset Management Market Study, originally launched in November 2015. It focused on identifying if the market was working effectively and on how asset managers compete to deliver value for money to consumers.
Given that the study suggested that price competition within the industry was weak and the enhanced focus that MiFID II brings to the market in relation to disclosure of costs, we felt it was worthwhile reiterating some of the key findings outlined in the study.
A link to the FCA Asset Management Study (Final Report) can be found here.
Findings covered four key areas:
- Price competition is weak within the Asset Management industry, particularly in the active management arena;
- This is largely driven by price clustering and firms not competing on price to win new business;
- Active management prices have remained stable for the last 10 years and profitability of firms operating in this sector was high (from the sample) at an average of 36%, whereas Passive fund prices have fallen over this period, suggesting potential scope for further price competition in the active sector;
- Analysis of the profitability of asset managers, based on gross overall performance, indicates that a higher amount is taken in annual management charges than would have been the case in a more competitive market.
- There was a wide variation of performance versus price with both active and passive funds, on average, underperforming their chosen benchmark* after fees were taken into account;
- Typically, active funds underperformed their benchmark with performance being varied, and there is no evidence to suggest that higher priced active funds consistency return better performance when net of charges;
- Passive funds also underperformed their benchmark (although this is inevitable to the extent of deductions for fund charges);
- Tools such as best buy lists do not appear to help investors identify products that, on average, outperformed relevant benchmarks after charges;
- There appears to be no clear correlation between level of charges and performance, with some evidence to suggest that cheaper active funds outperformed more expensive active funds once charges were taken into account;
- There is evidence that active funds performed worse than passive funds and this was largely due to the higher charges associated with this active funds;
- There is little evidence of consistent outperformance of the relevant benchmark over time and this provides a challenge for investors when fund selecting;
- However, there is some evidence of consistent underperformance and these funds tend to be either closed or merged with better performing funds;
- Absolute Return funds often provided misleading performance information to investors. For example, many absolute return funds do not report against the relevant target return, with some reporting against cash;
- Concerns were also raised about the wide-ranging targets and charges of absolute funds, which provide barriers to clear performance comparison.
* Benchmark issues – Firms usually use some form of benchmark to enable them to demonstrate how their fund performance ‘compares’. The study found several issues with firms’ use of benchmarks. First, firms did not always use an appropriate benchmark and that presented a misleading picture (see comment re Absolute Return funds above). Second, some firms used different benchmarks in marketing material, again leading to a misleading picture. Finally, some firms did not use a benchmark at all, making it more difficult for investors to assess the fund’s performance. The FCA is consulting on these issues and some new rules are expected.
Clarity of Objectives and Charges
- Evidence from the study suggests that some investors are paying “active” prices for funds that are, in reality, largely passive. For example, funds that typically track a benchmark but take a small “active” position either side;
- Overall, customers rarely engage with the charges associated with investment funds – often to their detriment. Investor awareness of charges is “mixed and often poor”, although this is largely in relation to retail investors, with many unaware of the charging structure of firms and the level of charges they are paying. (And a recent survey found that many investors have been paying on average 30% more in fees than was disclosed by some funds.)
- Institutional investors were much more aware of the level of charges being paid.
- Large institutional investors tend to negotiate a more attractive price;
- Smaller ones are often unable to access beneficial pricing structures and tend to utilise investment consultants, who do not appear to drive price competition;
- There are primarily three investment consultants (Mercer, Aon and Willis Towers Watson). These firms retain high market shares and have low switching levels, with conflicts of interest identified;
- Investment consultants generally are unable to identify managers that offer better returns for customers;
- Conflicts of interest were identified amongst investment consultants, in particular relating to those offering a combination of advice and fiduciary management;
- Retail investors tend to not benefit from economies of scale when money is pooled / consolidated through direct-to-consumer platforms;
- There is a range of different charges that investors can be subject to and this has implications for transparency.
What does the FCA propose to do?
The FCA has proposed remedies in three areas:
Remedies which provide protections for investors who are not well placed to find better value for money:
- Strengthening the duty on fund managers to act in the best interests of investors through:
- Outlining expectations of what is deemed to be value for money;
- Increasing accountability by introducing a new prescribed responsibility under the Senior Managers and Certification Regime (SM&CR) to act in the best interests of investors including a consideration of value for money;
- Introducing a minimum level of independence in governance structures, such as reforming the existing Authorised Fund Manager (AFM) board structure to have a majority of independent members and an independent chair;
- Proposing and seeking consultation on fund managers returning risk-free box profits to the fund and disclosing box management practices to investors. (Box profits are the profit generated through the difference between the buying price and the selling price on dual-priced funds, which can be kept by the AFM);
- Making it easier for fund managers to switch investors into cheaper share classes through consulting on removing barriers for firms to move investors to cheaper share classes without express consent where this is deemed to be in the best interests of the investor;
- The FCA is also considering whether a phased-in sunset clause should be introduced for trail commissions.
Remedies which will drive competitive pressure on asset managers:
- Supporting the disclosure of a single all-in fee to investors as opposed to the current non-transparent fee structures, including asset management charges and an estimate of transaction charges. Consultation on proposals will take place, with the FCA aiming to identify and test ways to improve the effectiveness of any forthcoming disclosure;
- Encourage increased transparency and the standardisation of costs and charges information for institutional investors;
- Supporting a consistent and standardised disclosure of costs and charges to institutional investors to improve the way in which charges are communicated to investors. An independent chair will work with stakeholders to identify what action is necessary, with the FCA recommending that both industry and investor representatives agree a standardised template of costs and charges;
- Consulting on rules so that performance fees are only permitted above the fund’s most ambitious target and consider whether further policy action on performance fees is appropriate;
- The FCA will chair a working group to consider how to make objectives clearer and more useful for investors, before considering any rule changes.
- Subsequent rule changes (following consultation) will focus on the following areas:
- An AFM should make clear to investors the reasons it has chosen a specific benchmark, comparator or numerical target for a fund;
- An AFM should make clear to investors the reasons it has chosen not to use a specific benchmark, comparator or numerical target for a fund and it would be prevented from using any other benchmarks or comparators in marketing material for that fund;
- If an AFM chooses to present their past performance, they must do so against the most ambitious returns target they hold out to investors (if any);
- The FCA is recommending that the DWP continues to review and remove barriers to pension scheme consolidation and pooling. The FCA has identified that by pooling assets and consolidation, some schemes will achieve beneficial pricing through economies of scale.
Proposals to improve the effectiveness of intermediaries
- The FCA is considering making a market investigation reference to the Competition and Markets Authority (CMA) to further investigate investment consultancy services. The three largest investment consultants have provided undertakings in lieu of the reference which the FCA is proposing to reject, although this is subject to public consultation;
- The FCA is recommending that the Treasury considers extending the regulatory perimeter to include all aspects of investment consultancy services, subject to the outcome of the provisional market investigation reference to the CMA (above);
- The FCA will launch a market study into investment platforms to identify how competition is working in that market. This comes as a result of inconsistent and complex pricing structures, making it difficult for investors to identify the costs associated with platforms.