Late last year the Financial Conduct Authority (FCA) launched a consultation on the operation of the investment management industry (I wrote three blogs on it starting here http://blog.ptluk.com/asset-management-time-for-a-cold-shower). They have now published their interim report (apparently it is still summer!) and it could be a game changer for the investment industry. A great big game changer.
Firstly the basics. This is an interim report (all 206 pages plus nine annexes of it) and, in effect, acts as a consultation. It flags some more work they plan to do, identifies some problems they don’t like and proposes a first set of solutions. The consultation closes in February and a final report will be published next year.
On the assumption that the final report sticks with the solutions included in the interim report (and perhaps adds to them) the full report will need changes in the FCA Code of Business Sourcebook (the “COBS”) and potentially also the law. In other words, no changes are likely to be mandated for at least a year although we’ll all have a clear feel for the direction of travel well before then.
So, at a high level, what does the report say? Well, if my son bought this sort of report home from school he wouldn’t just get a stern talking to we’d probably have to threaten to take his games console away. In summary, the FCA wants the investment industry to do more than “try harder”. It wants it to radically reform the way it operates. It is, also, very unhappy about some features of the industry.
Who is the FCA blaming? In short, everyone. Active managers, passive managers, semi passive managers, absolute and target date managers, consultants, EBCs, investment consultants, internal fund governance committees, external fund governance committees, IFAs and many trustees. In fact, the only related party who they haven’t criticised is themselves.
What are the key problems? Crickey – where to start!
The FCA thinks:
There is insufficient competition in the price of investment management services. The economies of scale are adding to manager profit margins as opposed to lower prices for consumers.
Fund managers are controlling some underlying costs (those taken from the schemes assets) but not all of them.
The internal fund governance bodies of fund managers do not, adequately, scrutinise fund managers own costs and so do not exert significant pricing pressure on them. Nor do they routinely consider value for money.
The incentives paid to employees of fund managers are not clearly aligned to the interests of the consumer and, in fact, may be the polar opposite.
Overall, active managers for institutional investors only get a return marginally above benchmark and there is no correlation between price and performance.
There appear to be a large number of active managers (at the price they charge) who are, in effect, “closet trackers”.
Fund managers, individually and collectively, are poor at reporting performance against benchmarks.
Investors (perhaps led by their consultants) tend to focus on the wrong metrics when considering the performance of fund managers and fail, almost entirely, to consider the performance of their investment consultants.
Most investors are poorly placed to negotiate price and, in any event, do so poorly.
Investment consultants, while adding value in certain functions, routinely do not add value in relation to improved investment performance. They are also subject to all sorts of conflicts of interest that are poorly understood by their clients and poorly managed by the consultant. The FCA are particularly exercised by those consultants who offer fiduciary management services.
There is little or no standardisation in performance, cost reporting or methodology assessment. This makes it difficult for consumers to compare one fund manager with another. It can also mean that one fund manager can be both highly rated and not at all rated by two different investment consultants.
What are they proposing?
Amongst other things:
A strengthened duty on fund managers to act in the consumers’ interest.
An all in fee that covers all of the costs of investment.
Requiring fund managers to be clearer on their objectives, their benchmarks, their charges (and to have more standardisation of them all) and to provide tools to allow investors to spot serial under performers.
A consultation on referring the investment consultancy market to the Competition and Markets Authority.
Recommending to the government that institutional investment advice be a regulated activity.
In my first blog on this matter earlier this year, I described this process as a cold shower for the investment management industry. I was wrong. This is far more far reaching. It is an ice bath.