The Financial Conduct Authority (FCA), the regulator of the UK’s £7 trillion asset management industry, responsible for market confidence and the protection of millions of retail investors, has reconfirmed in a recent study that the asset management industry is failing its customers.
Although the report is comprehensive, it can be summarised by saying that the FCA has found evidence that the asset management industry is overcharging retail investors, fails to disclose relevant information and uses irrelevant data to market their products.
Fund management fees
Despite their obvious concerns, the FCA has stepped back from introducing legislation now that would make it easier for investors to understand how much of their own money is being used to pay for investing services. The preference would appear to be to allow the industry to drive changes and improve disclosure and value for money on its own. The very fact that less than 10% of UK asset managers even submitted their views to the original Interim Report MS15/2.2 suggests that perhaps they see the FCA as having more bark than bite.
Financial planning firm, Capital Asset Management, have been fully onboard with fee transparency for many years and in 2016 implemented their fee transparency strategy. Alan Smith, the CEO, argues:
“We understand that the FCA is not a price regulator and aspires to see market forces drive down costs for investors. Unfortunately, the current structure creates information asymmetry where the investor is kept in the dark about precisely how much and how often they are being charged and therefore are unable to know the true cost of investing or make an informed decision as to the value they are receiving or be able to shop around.
The FCA's suggestion of using a single, all-encompassing price to disclose fees and charges is welcome and can't come soon enough. Indeed, MiFID II legislation, addressing the issue of transparency in investor fees, arriving in 2018 will help but needs to go further if the UK is to lead the world in terms of transparency and value for retail customers.
We would like to see a single number for charges to cover all fees and costs, including trading costs, stamp duty, market impact costs, cash drag and research. It should be sent directly to the investor on one page and not lost in huge indecipherable documents that few investors ever choose to read.”
Past Performance data used in marketing
The FCA quite clearly stated that for retail investors, past performance is not a good guide to future investment performance, and confirmed that their research found that it is difficult for investors to identify outperforming funds (if such funds exist). The report includes a stark commentary stating that within academic literature there is little evidence of persistence of outperformance, and where persistence has been identified, it relates to poor performance.
“We agree entirely and as an independent firm of chartered financial planners providing advice to retail investors, we don’t refer to past performance as part of our research and due diligence process. Therefore, if the FCA and all the empirical research confirms that it provides no value then why allow it at all?
Historical fund performance data can be described as misleading and therefore can lead to poor outcomes and disappointment for investors. It also leads to fund management groups launching vast numbers of new funds each year in the hope of finding a successful one. Subsequently, many funds underperform and are quietly closed or merged with other funds leading to market distortion through survivorship bias.
The small number of funds that have performed well (often more by luck than skill) are then marketed heavily based on short-term performance data and end up on Best Buy and Top 100 fund lists and are bought in large volume by the retail investor and their advisers.
Therefore, in order to avoid this misleading approach to luring investors, all advertising referring to past performance should be banned. After all, in other industries (for example the pharmaceutical or health industries) if an organisation cannot prove that their product or service can deliver future outcomes (in this case, above market returns) they would not be allowed to use irrelevant data to market it”.
Investment fund benchmarks
Asset management firms often align their retail funds a particular ‘benchmark’ against which to measure ongoing performance. This acts as a form of ‘ruler’ so that the retail investor can measure how well their investments are doing.
In their report, the FCA found that the use of benchmarks by the industry is not helping the retail investor to make well-informed decisions. After all, what objectives does the retail investor have for the investment of their money?
Different asset managers use different benchmarks and even use different benchmarks within their fund range to match different investing strategies. This makes it a bewildering task for a retail investor to compare and contrast actual relative performance, or make good decisions about switching funds.
“Capital believe that performance and benchmarks should be reported to the retail investor in a way that is clear, and appropriate to the objective. Using a benchmark purely to evidence some form of outperformance that is totally aligned to asset manager outcomes should be banned. Each fund should have a specific and fair performance objective, for example, to outperform CPI inflation by +2% a year. Every year the asset manager should produce a one-page statement which illustrates clearly in money terms how the fund performed and whether the goal was met, perhaps over one year and since the inception of the fund. Simple and clear, backed up with evidence. This should be done on a net of charges basis.”
By forcing full disclosure of all costs in a simple, easy to understand format, banning the use of misleading and irrelevant information to sell funds and providing regular statements of how the funds are performing against their benchmark will all combine to create a more fair and competitive marketplace. This will benefit not only the retail investors but will lead to greater trust and value placed in the industry as a whole.
Alan Smith, CEO explained "Although this report is very welcome, it remains light on clear action steps and plans for reforming legislation. As a firm working within the financial services market and dealing with clients and families investing for their future financial security, we want to be part of a profession we can be proud of. Driving change that will obviously benefit the public is essential if we are to see confidence and trust improving”.