The follow up to the FCA’s study of the fund management industry

The follow up to the Financial Conduct Authority’s (FCA) Asset Management Study has been released, meeting with mixed reviews from those in the industry who were hopeful they’d adopt a more direct and controlling approach over the dealings of active fund managers.

To re-cap, an active fund manager tries to outperform a benchmark index by timing when to go in and out of investment markets and/or using a stock-picking strategy. For example: a UK equity fund manager using these techniques to try and outperform the FTSE 100 Index.

However, academic evidence has shown that the majority of active manager’s returns simply fail to outperform their benchmarks over the longer term. So back in 2009, Cooper Parry Wealth took the decision not to use active fund managers, instead opting for passive, or index tracking funds.

The FCA’s first paper highlighted a number of issues with actively managed funds, in particular high or hidden costs, underperformance and how adverts in the financial media, such as ‘best buy’ lists, are actually detrimental to the consumer.

Our summary of that paper can be found here

In the follow up ‘Final Report’, the FCA has taken aim at the high charges active fund managers levy on investors suggesting that consumers aren’t getting value for money. They said, “there is no clear relationship between charges and gross performance of retail active funds in the UK” and that “there is some evidence of a negative relationship between net return and charges. This suggests that when choosing funds, investors paying higher prices, on average, achieve worse performance”.

It’s really pleasing to see the FCA back up a message that we’ve stuck by for years. But what are they actually going to do about it? Unfortunately, this is where the second paper lacks substance and doesn’t provide any solid solutions. Instead, they’ve made some suggestions and will follow up on these later in the year. They include:

• An ‘all in’ fee for retail investors that includes an estimate of trading costs (sometimes referred to as portfolio turnover costs). We have always done this based on academic evidence from the UK and the US and would have liked the FCA to roll out an industry benchmark for calculating these hidden costs.
• A tightening of the rules for active fund managers who charge performance fees. This includes more ambitious performance targets and consequences for poor performance against the criteria set out.

Other interesting points to note from the follow up paper are:

• The FCA are trying to push a culture change rather than any strong legal stance by saying fund managers have a duty to act in the best interest of investors. This should be the starting point for any advisory firm! To action this, the FCA said it will introduce a responsibility for asset managers to consider the ‘value for money’ that they deliver under the Senior Managers and Certification Regime, due to be applied in 2018.
• Fund boards will have to appoint two independent members to improve governance, and in particular, to assess whether or not investors are receiving value for money.
• One of the main reasons for pointing the above out is that many active investment managers are very profitable, whilst delivering underperforming investment funds.
• There will be an investigation into whether investment platforms enable retail investors to access products that offer value for money. The FCA will also be looking at what can be done to enhance competition between platforms to improve outcomes for consumers.
• They are also considering broadening the scope of reforms to retail investment products sold by insurance companies, such as pensions, investment bonds and endowments.

Overall, whilst the messages presented by the study are positive, it lacks the clear direction that some had hoped for.

We’ll watch out for any concrete changes the FCA will look to implement in the future and hope that before then, active fund managers take note of the negatives, follow our example, and start putting investors first. That’s the most important thing.

Past performance can’t guarantee what investments will do in the future, there’s more to it than that. The value of a portfolio can go down as well as up, so there’s a chance you’d get back less than you put in.