Robin writes: The UK’s financial regulator, the FCA, recently set out new rules designed to improve competition in the asset management industry. I must say I’ve become a little bit cynical about the time it’s taking to persuade the big fund houses to start putting consumers’ interests ahead of their own. We won’t see wholesale improvements, in my view, until the FCA forces companies to comply, and until investors start successfully suing fund houses that have deliberately hidden the full extent of fees and charges or have been dishonest about their past performance.
But, for an alternative perspective, I’ve invited CHARLES PAYNE to give his reaction to the FCA’s announcement. Charles has worked in the fund industry for 35 years, and is best known for the 14 years he spent at Fidelity International, where, among other things, he served as Investment Director and Head of Equity Product Management. He recently left the industry after becoming increasingly disillusioned with it. In this post, he gives the FCA’s new rules a cautious welcome, and calls for a new breed of fund house CEO to tackle the challenges the industry faces.
A GUEST POST BY CHARLES PAYNE
“But at my back I always hear, Time’s winged chariot drawing near” –
Andrew Marvell, ‘To his Coy Mistress’
If the FCA’s latest paper on the asset management industry came as a shock then you haven’t been paying attention. In reality it is the next foot to fall on a journey that arguably started back in 2013 with the Retail Distribution Review, a journey that has recently included the first fines for managers charging fully active fees for “closet indexing” — a long-voiced criticism of the ‘rump’ of the active industry. So how best to understand what the FCA is saying?
Value for money
In essence, the investment industry charges you a fee for taking your money and placing your bet at the casino. How do you measure if you got value for money? The FCA has inevitably not (yet) been prescriptive here and left it up to individual managers to make a case as to what VfM looks like. Here are a couple of simple thoughts:
- Ex-post tracking error — if this is insufficient to allow the client to make at least twice as much in outperformance as the manager takes in fees then it cannot represent VfM.
- Historic outperformance — again if historically the client has made less in excess return than the manager has made in fees, then it cannot be VfM.
Fund boards
To date, fund boards have had no value in looking after the interests of the end investors, exclusively made up as they have been by the asset management firm’s own staff and their employed administrators. It is excellent to see that some firms have already “got it” and are not only actively recruiting these new breed of external non-executive members, but intend to make them chairs. Notes to fund houses: 1) don’t be like the investment trust world of ‘musical chairs’ and simply sit on each others’ boards, and 2) pay their costs yourselves, don’t pass them on the funds and your clients — that’s surely not what the FCA had in mind.
Buying and selling funds
The final end of dual pricing and the manager taking a spread — unarguably a good thing. There will now be a single price for both buyers and sellers; whether this will be a true mid in all case or should ‘swing’ daily to reflect the weight of buyers versus sellers is a point for debate. There is some theoretical support for ‘swinging’; however the patchy utilisation of existing anti-dilution levies which were meant to protect individual investors from the impact of big institutional flows suggest that a simple unswung mid is far less open to abuse.
Movement to cheapest share classes
The FCA is simply following the logic already applied elsewhere to savings accounts and fuel tariffs. Fund ranges have a baffling array of share classes, many of which serve to obscure the fact that institutional buyer can access exactly the same product for far less than a retail buyer can. This differential has always been batted away with a generalisation that it costs more to keep transaction records for thousands of individual unit holders. It undoubtedly does, but listed company registers are able to do it effectively and cheaply, and to say it cost up to four times more than the investment management of the fund is stretching the argument beyond breaking point.
So, in summary, we see four hugely positive directions of travel:
- Better representation of smaller shareholders
- Greater focus on value for money
- Simplification around dealing and share classes
- Pressure on the margin between institutional and individual investors
As Moody’s have been quick to point out, these will change the margin dynamics of the industry — an industry which according to the annual NYU Stern annual study enjoys a gross margin globally of 70% (January 2018), the 6th highest of the 93 industry sectors the survey divides into.
And yet is it all doom and gloom for the industry as many are predicting? The answer is, I am convinced, a definite no. So in the face of declining margins, what should an active house do?
- Cut overheads — hard. If it differentiates your proposition, keep it in house. If it doesn’t, outsource. Your client doesn’t need to pay a premium for it.
- Reduce the number of funds — again, hard. The ‘all things to all people’ supermarket powered not by superior investment performance but by superior marketing is reaching the evening of its day. Focus on where you have a genuine edge, and either cut fees, close, or white label index the rest.
- Abandon the ad valorem charging model, and cap the income you make from a fund so that over a certain size the fees actually fall.
- Unbundle fees. End dirty pricing and instead break your fees down into a charge for 1) market access 2) active outperformance potential (including performance fees) and 3) additional mutual fund administration.
Finally one concern and one piece of heart-felt advice. The concern is this: although outstanding active fund managers are rare, outstanding CEOs of active fund management houses are rarer still. In 35 years I’ve had the privilege of working for just one who was genuinely in this category. It’s time for a new breed of CEOs of investment business, ones for whom ‘steady as she goes’ is no longer good enough, but instead ones who understand that the long term competitor is not the firm in the impressive building at the other end of Moorgate, but Ant, Paypal, and Amazon.
And the piece of advice to these CEOs? Investment is a complicated world inhabited by very clever people. Please don’t harness all that brainpower to game and exploit the inevitable loopholes in as yet still emerging FCA drafting. Instead look at the horizon, understand where this is going, and instead use your intellectual horsepower to create the firm that wins not in two years, but in twenty years’ time. Be remembered not for how much you made, but what you built.
I’m now off to find a fund board that is looking for a critical but honest non-executive member!
Related posts:
Lessons learned from 35 years in the fund industry
My 10-point plan for reforming active management
How can TEBI help you?
Help for institutional investors
Robin is a journalist and campaigner for positive change in global investing. He runs Regis Media, a niche provider of content marketing for financial advice firms with an evidence-based investment philosophy. He also works as a consultant to other disruptive firms in the investing sector.
