The UK financial regulator highlights a number of shortcomings in the country's asset management sector, saying that price competition isn't strong enough, and that reforms must be made to deliver better value to end-investors.
The UK’s £6.9 trillion ($8.83 trillion) asset management industry suffers from “weak price competition” that hurts end-investors and the sector must put clients’ interests first, such as making it easier for them to adopt cheaper options, the country’s financial watchdog said in a report today.
The Financial Conduct Authority published its widely-anticipated Asset Management Market Study, published following an interim report on the sector last November. Today’s study analyses whether investment firms offer value for money.
The watchdog said it proposes to bolster the duty on fund managers to act in the best interests of investors, make managers more accountable and bring in a minimum level of independence in governance structures. The FCA proposes the idea of a single "all-in" fee to investors to make fund charging simpler. It is also consulting on the idea of requiring fund managers to return any risk-free box profits to the fund and disclose box management practices to investors. (Box profits relate to the spread between the price at which the fund can be bought and the price at which it can be sold. This reflects the cost of buying or selling securities in way that makes sure that new or redeeming investors do not dilute the value of existing investors' units.) Some media reports have said a move against such profits could hit managers’ revenues by up to 10 per cent.
The FCA’s study and recommendations come at a time when the financial services industry is already grappling with the European Union’s MiFID II directive, which becomes law next year. That directive is designed, its framers say, to make financial advice more transparent and improve investor outcomes. The UK asset management industry has already felt the impact of the Retail Distribution Review programme of reforms that kicked in from 2013. One effect already of such reforms has been to encourage greater use by intermediaries and managers of low-cost “passive” fund products such as exchange traded funds, raising fears in the sector of a sustained squeeze on margins and a need for consolidation to contain costs.
The FCA report made it clear that the financial case for paying more fees for the supposed “Alpha” from actively-managed funds is not obvious: “We looked at fund performance, and the relationship between price and performance. In our additional analysis, we found substantial variation in performance, both across asset classes and within them. However, our evidence suggests that, on average, both actively managed and passively managed funds did not outperform their own benchmarks after fees. This finding applies for both retail and institutional investors.”
The report goes on to say that price competition in the UK sector, notwithstanding reforms such as the RDR, is still not sharp enough. The report said “we also found high levels of profitability, with average profit margins of 36 per cent for the firms we sampled. Firms’ own evidence to us also suggested they do not typically lower prices to win new business. These factors combined indicate that price competition is not working as effectively as it could be”.
Among recommendations in the report is the proposal to make it easier for fund managers to switch investors to cheaper share classes; the FCA is seeking views on whether it should introduced a phased-in sunset clause for trail commissions.
The stakes are high: the UK asset management sector is the second-largest in the world, overseeing around £6.9 trillion of assets, which more than £1 trillion is managed for individual retail clients and £3 trillion for UK pension funds and other institutional investors. The sector also manages about £2.7 trillion for overseas clients. The FCA report studied more than 20,000 share classes and 30,000 investment strategies.
“The final report follows the interim report published last year which found that price competition is weak in a number of areas of the industry. Despite a large number of firms operating in the market, based on our sample, we found evidence of sustained, high profits over a number of years. We also found that investors are not always clear what the objectives of funds are, and fund performance is not always reported against an appropriate benchmark. Finally, we found concerns about the way the investment consultant market operates,” the FCA said.
“Although we recognise that the proposed package of remedies will probably increase costs for some firms, we expect that the benefits will outweigh any costs. We also expect that any improvements to outcomes for investors will lead to the UK asset management industry being a more attractive place to invest and therefore improve the relative competitiveness of the UK market,” the FCA said.