It has been a long time coming, but today the Financial Conduct Authority, the UK financial regulator, completed its review of the funds industry and laid out what its action plan will be for the years ahead. But is it a shake up that will benefit investors in funds, or will it be more of the same?
There have been wide concerns for some time now that many fund managers charge investors too much, for funds that simply are not able to beat the benchmark indexes. Investors are frequently paying money to lose money, while fund managers continue to earn very nice salaries. The government and the FCA have both taken notice.
“The asset management sector is important to the economy, managing the savings of millions of people and in the current low interest rate environment it’s vital we help people earn a return of their savings,” said Andrew Bailey, Chief Executive of the FCA. “We need a competitive sector, attracting investment into the United Kingdom, which also works well for the people who rely on it for their financial wellbeing.”
For starters, the FCA fund review has found that price competition in the market is weak. While there are many, many fund managers, most of these firms are very profitable, and remain so, consistently. Fund managers – and financial intermediaries – seem less concerned about competing on price, unlike other sectors. Even the insurance industry is having to work hard to win and keep business, not so much in the asset management market, says the FCA.
Going beyond this, another big concern is that fund managers are not always clear what the objectives of a fund are. This gives them a little bit of flexibility to change those objectives when it suits them. Such changes cannot be too egregious, but if you are vague about what it is you are setting out to do in the first place, it is harder to hold you to account when you fail to achieve it. Beyond this, funds are not always reporting their performance against the right benchmark – managers are choosing benchmarks that make them look better than perhaps they really are.
So what is the FCA going to do about all this?
The FCA fund review has proposed a wide range of changes. Many of these – like the requirement that funds have at least two independent directors on their boards – are things the institutional investor community have been demanding for a number of years now.
For private investors, it will be good to have more transparency on fees. Funds have traditionally included all kinds of fees beyond their simply annual management fees, which investors have ended up paying. This is important, as the fees are deducated from the value of the fund, regardless of how well it is doing. They can end up being a significant drag on performance. Hiding fees in the small print eventualy created the need for the Total Expense Ratio or TER, a measure of the total cost of a fund. The FCA says that it will “support the disclosure of a single, all-in-fee to investors.” In other words, funds will likely now have to provide the total cost figure up front.
“The FCA’s pragmatic approach to issues such as a single all-in fee is good news for firms,” adds Amanda Rowland, a partner with PwC. “Changes required by EU regulation are already in flight and I’m sure that the industry can help develop solutions with the FCA to ensure the best outcomes for customers around clarity of charges.”
The regulator is also going to chair a working group to look at how the investment objectives of funds can be made “more useful” and will consult on how benchmarks are used and performance is reported.
What about ETFs?
Well may you ask. After all, exchange traded funds already have to track a specific benchmark, and are judged on how close to that benchmark their perform, not whether they beat it or not. Also, ETFs are already very cheap, and there is growing evidence that the biggest providers are indeed competing fiercely on price. If anything, the existence of the growing ETF market is more of a direct threat to the way the funds industry looks after your money currently than anything the FCA fund review suggests.
Why then should we still worry?
Many pension schemes, be they company pension schemes, private sector schemes or indeed self-invested versions, are still heavily founded on actively managed funds, not ETFs. Most of the money is being managed by no more than a dozen groups. Allocators of pension assets tend to be very conservative and will invest with big brand names because they are big brand names. Nobody likes taking a risk on a smaller or less well known fund manager, regardless of how his performance numbers look. This has unfortunately created a culture where big brand managers are able to charge expensive fees and still underperform the stock market. That there is not more outrage being voiced about this is because many people are simple unaware of the pressing issues, as they quietly pay their monthly contributions into their pension funds.
“For too long, customers have struggled to understand the real cost behind pension funds, and only a clear and simplified market will help them make better choices,” says Dave Prentis, general secretary at UNISON, the UK public service union. “
The Armchair Trader was established to support self-directed investors, and help to educate the wider community about their options. Our advice is do your homework – take the time to carry out some independent research into funds and how to pick them for both your pension and your ISA. We will be returning to this topic again in the near future, so make sure you come back soon. In the meantime, you can use our forums to be kept more up to date on the issues we are discussing here.
