On the 18 November the Financial Conduct Authority (FCA) published the Interim Report to its Asset Management Market Study, noting several areas for further focus. The overall study aims to assess how competition in the market is working and to what extent investors are getting value for money, and is set to be published in February 2017.
Among other topics, the 200-page report covered fund fees, platform costs, passive funds, ratings agencies and model portfolio transparency. Here we look at 5 of the key points and how Asset Managers should be responding in advance of the full report's release.
Whilst the FCA’s CEO Andrew Bailey has stated that the report is neither advocating active or passive strategies, the findings acknowledge the need for more exposure for passive funds in buy lists and recommendations. The issue, according to the FCA, comes from the way that passive funds are often rated.
The report found that ratings agencies have been known to apply active methodologies to passive funds, despite their differing mandates. This, according to the report, is resulting in passive funds getting an ‘average’ rating when in fact, judged by the appropriate criteria, many passive funds would get a better score.
Fund groups who are worried about their passive products being overlooked by investors should consider looking at promoting suitable passive ratings such as FE’s Passive Crown Ratings, launched last year. The FE Passive Crown Ratings make a purely quantitative assessment, looking at tracking difference, tracking error and fund size (as a proxy for liquidity). Find out more about FE Passive Crown Ratings here.
Third party ratings agencies
The FCA has also raised concerns over the conflict of interest that arises when payments are taken by ratings agencies to rate funds, and is further concerned that some third party ratings agencies do not offer a whole of market review which leads to a ratings bias.
Whilst the conflict of interest is indeed an issue, many ratings agencies have responded to the assessment by highlighting the role that ratings play in making the funds industry more accessible.
However, the judgement found that for ratings to truly play a role in increasing transparency they must hold no bias towards any corner of the market or fund group.
To avoid bias, FE’s ratings are quant-driven, with a qualitative overlay for fund to be featured on our FE invest Approved List. No payments are taken to rate any funds, find out more here.
The all-in fee
An ‘all-in fee’ was proposed in the report, scrutinising the current approach to cost disclosure in active management. The regulator stated that investors are still not clear about what they may end paying because some charges, such as transaction costs, are either not disclosed, or are estimated and therefore risk being inaccurate.
Although the FCA have focused on this topic, and rightly so, it’s worth remembering that Post Retail Distribution Review there have been some large steps to improving cost disclosure in the world of active management. For example, the introduction of an Ongoing Charges Figure (OCF) - which combines the annual management charge (AMC) as well as additional charges for things such as fees paid to the trustee, auditor and regulator – has made investors much more aware of what they are paying for a fund.
The Regulator proposes four approaches to an all-in fee:
The current OCF becomes the actual charge taken from the fund and the manager makes up any shortfall around dealing commissions and transactional costs.
The OCF becomes the actual charge, but with the fund manager estimating transaction costs.
A single charge including all transaction costs, but with an option for ‘overspend’ if additional trading is deemed necessary.
A single charge with no overspend option, so the asset manager would have to fund any difference between the forecast and actual trading costs.
The FCA also made it clear that using AMC as the headline charge on factsheets is unacceptable as it is an inaccurate representation of what investors could pay, and estimated that extra costs outside AMC could amount to as much as 0.9%.
It’s fair to say that the findings were predominantly positive on platform discounts.
Interestingly, research showed that platform discounts were not in general very large, ranging from a mere 15 to a slightly more significant 38 basis points. Further, it was found that the prices of best-selling funds did not tend to differ across platforms.
However, the report did note some potential for concern in that platforms could potentially give preference to their own in-house funds or certain funds in their lists or promotions. Despite this though, the FCA found no evidence that suggested a systematic preference to certain fund houses.
On the whole, the regulator found that platforms enable as opposed to hinder access to market for asset managers, and can offer investors a cheaper way to buy best-selling funds.
Clearer fund objectives
The FCA highlighted concern over the clarity of fund objectives and the appropriateness of benchmarks used to judge performance.
The overarching theme of the FCA’s concern here was that it is often difficult for investors to assess whether their expectations have been met. Further, if they are left unsatisfied with an investment then choosing a more suitable alternative is difficult due to the lack of clarity around what a fund aims to achieve.
The FCA stated that they are interested to see what can be done by managers to make it easier for investors to pick the right funds, and better understand what they can expect from their investment. Part of this was to be clear about the fund’s objectives however, the FCA’s research also found that fund reports put together by managers needed to be more focused to make it easier for clients to evaluate performance.
FE’s Precision+ Documents service assists with fund reporting helping you communicate with clients clearly, and with accurate data.
The FCA publishes its full findings in February next year, but the interim report indicates some of the areas of focus of the overarching report which Asset Managers can start addressing today.
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