The FCA should get tough on the fund management industry

The financial regulator has taken a swipe at high fund management fees. The industry will resist change, but the FCA needs to act quickly and decisively, says Merryn Somerset Webb.

170630-gilbert-b

I was rather looking forward to seeing the Financial Conduct Authority's final report on the asset management industry. Its interim report out last November was a criticism-jammed corker, so hopes were high that this week's report would be just as entertaining for those of us in a state of permanent irritation with the fund management sector.

The first bit didn't disappoint. The report notes that while funds should compete on price (given that it is the only thing we know in advance), they clearly don't. If they did, the industry wouldn't make consistently high profits (an extraordinary average net margin of 36%) and the cost of funds that claim to be actively run wouldn't have been static for a decade (at an average 1.6%) at a time when you can buy a perfectly adequate passive fund for 0.2%.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

It recognises that paying a high price for a fund does not guarantee good performance, it only raises the risk of poor net performance. It clocks that fund management firms do not automatically put the interest of their clients first something of a shame given that, one way or another, we have all outsourced our hopes and dreams to them and concludes that "investors may not be achieving value for money" (bureaucratic understatement at its best).

All in all, as David Morrey of Grant Thornton said quite rightly: "If you didn't like the interim report, you won't like the final report." You might, however, be rather relieved by it. That's because, while the FCA has not pulled back from complaining about the wickedness of the industry, it has softened on forcing solutions.

Advertisement
Advertisement - Article continues below

It tells us lots of things should happen: the obligation for fund managers to act in the best interests of investors should be strengthened; managers should have at least two independent directors on their boards; a stunningly awful practice whereby fund managers make money (known as box profits) out of keeping the difference between the bid and offer spread on their funds even if the deal is matched internally (so the spread doesn't exist) should be banned; managers should be clear about which benchmarks they use and how using them alters their strategy; and there should be an "all-in fee" that tots up every single cost to the fund (including trading costs) so that investors can compare funds on a like-for-like basis.

What the report does not do is insist that all these things are done immediately. Take my particular interest, the all-in fee. Mandatory standardisation of charging: one fee, with absolutely everything in it, calculated in the same way by every firm. Introducing it would bring transparency and lower prices into the game instantly. Lovely. The report says the FCA "supports" it. But they aren't insisting on it now. There will be a consultation consultations galore, in fact."What do we want? Fund managers to, you know, think a bit about their customers. That kind of thing. When do we want it? Soon. Well soonish. After a bit more consultation. Can't ever have enough consultation." Not exactly a day of rage, is it?

So what changed between the interim report and the final report? Read the whole thing and you will soon see the answer: a whole lot of doubt-spreading by the industry.

My favourite part comes on page 84, where the FCA reports on conversations with stakeholders about the all-in fee. It turns out that several respondents were concerned about the "practical complexities" of an all-in fee. It'll be hard to figure out transaction costs, they said. After all, trading costs "cannot be predicted accurately ahead of time".

This is absolutely killing.This group of people insist that it makes sense for us to pay them outrageously high annual fees on the basis that they are so good at complex forecasting they can can tell us look at, say, the 2,000 stocks listed in the UK and forecast which of them will do better over anything from a six month to a 10 year peiod than the others based on a pile of mostly made up spreadsheets.Thissame group of people also insist there are insurmountable "complexities" in extrapolating what their own trading costs will be over a 12-month period from decades of their own data. Hilarious.

My next favourite bit is where more stakeholders (probably the same ones) tell the FCA they are a bit worried about this all-in fee thing because bundling costs into one number might make it "harder to compare funds" as if having lots of different numbers and some really important ones not disclosed somehow makes it easy.

Advertisement
Advertisement - Article continues below

Then there is the bit where they say they are worried that an all-in fee will make UK funds look more expensive. This misses (presumably on purpose) the whole point of the exercise: to show just how expensive they are. These aren't the only bits in the report that made me giggle, but I think you get the picture: no industry gives up huge profits without one hell of a fight.

The good news is that the cat is out of the bag. The FCA knows what the industry is up to. The smart money in the industry knows it knows. Aberdeen's Martin Gilbert gets it: "I have stated several times that I am in favour of all-in fees including all costs", he said this week.

And most importantly of all, consumers are getting it too. Fifteen years ago all the shockers in the FCA report would have been news to the average fund investor. Now they are all well known. So change is coming anyway, partly through the work of the FCA and some new regulation on the way from Europe, but also from the better managers pushing for it and the smarter of the consumers insisting on it.

All these things will work. Still, that doesn't mean we can down tools. There is more work to be done. So here's a challenge for Mr Gilbert: do it make the merger of Standard Life and Aberdeen the catalyst for introducing an honest all-in fee across the funds of the combined entity.

Here's one for the FCA: move faster. And one for investors: vote with your feet. There are fund managers out there charging perfectly reasonable fees (one good one told me last week that his firm's "direction of travel" is to get the management fees on all their funds down to 0.5%). There are funds that return the benefits of scale to their investors by offering to drop their fees as their fund grows. And there are funds that are run in a genuinely active way. Buy those and sell the others. That should do it.

This article was first published in the Financial Times

Advertisement

Recommended

Visit/investments/funds/600949/esg-and-ethical-investing-where-should-you-start
Funds

ESG and “ethical” investing: where should you start?

“Ethical”, or ESG investing (environmental, social and governance) is all the rage. But what exactly does it mean? And where should you start? Merryn …
9 Mar 2020
Visit/investments/funds/investment-trusts/600757/why-investment-trusts-are-the-best-vehicle-for-your
Sponsored

Why investment trusts are the best vehicle for your money

Max King explains the advantages of investment trusts – sometimes called closed-ended funds – over their open-ended counterparts (or Oeics).
11 Feb 2020
Visit/investments/stocks-and-shares/share-tips/600790/asian-income-stocks-where-to-find-the-continents
Share tips

Asian income stocks: where to find the continent's top money machines

International dividends shouldn’t only mean companies in the US or Europe – the Far East has plenty of big payouts to offer. Cris Sholto Heaton looks …
6 Feb 2020
Visit/investments/funds/neil-woodford/600717/woodford-investor-your-first-payment-is-coming-soon
Neil Woodford

Woodford investor? Your first payment is coming soon

Private investors left stranded by the collapse of the Woodford Equity Income fund will soon be getting at least some of their money back. But they wi…
28 Jan 2020

Most Popular

Visit/investments/property/601081/three-things-matter-for-the-uk-housing-market-now-and
Property

Three things matter for the UK housing market now – and “location” isn’t one of them

The UK housing market is frozen. And when it does eventually thaw out, the traditional factors that drive prices will no longer apply. The day of reck…
1 Apr 2020
Visit/investments/property/601065/what-does-the-coronavirus-crisis-mean-for-uk-house-prices
Property

What does the coronavirus crisis mean for UK house prices?

With the whole country in lockdown, the UK property market is closed for business. John Stepek looks at what that means for UK house prices, housebuil…
27 Mar 2020
Visit/investments/stockmarkets/601101/has-the-stockmarket-hit-rock-bottom-yet
Stockmarkets

Has the stockmarket hit rock bottom yet?

The world's stockmarkets continue on their wild and disorientating rollercoaster ride. Investors are still gripped by fear. So, asks John Stepek, have…
2 Apr 2020
Visit/investments/commodities/energy/oil/601107/oil-shoots-higher-have-we-seen-the-bottom-for-the-big-oil
Oil

Oil shoots higher – have we seen the bottom for the big oil companies?

Just a few days ago everyone was worried about negative oil prices. Now, the market has turned upwards. John Stepek explains what’s behind the rise an…
3 Apr 2020