It’s no surprise that there’s nervousness among asset managers in the run-up to the FCA’s interim report into consulting and fund management – both retail and institutional – due to be published before the end of the year, probably in November.
Some are more confident but there’s a lot at stake. Even if the industry walks from the dock, there’s been a huge data collection exercise. Guy Sears, former chief executive of the Investment Association, says its findings will inform the view of the sector taken by FCA’s new chief executive Andrew Bailey over the next five years.
The charge on the books is that the industry isn’t giving clients value for money. Certainly, there are plenty of critics who think the industry has a weak defence.
One of the reasons is ad valorem fees, charged as a percentage of assets managed, which are common across the industry. Thanks to generally rising markets, puffed up by easy money from central banks, these have given fund managers a free ride.
Consultants say managers work hard at tilting performance fees in their own favour. In an April discussion paper, Willis Towers Watson said there were arguments for them to be replaced with fixed fees. Mercer’s European director of consulting Nick Sykes said fixed fees would “bring certainty to the budgeting process”.
It is even harder for retail investors to get to grips with fee rates offered by different share classes, says Mackay.
According to a CFA survey, only 55% of managers believe their clients are capable of assessing products properly.
The FCA has already had one tilt at helping retail investors cut costs, the complex re-engineering of the personal investment industry known as the Retail Distribution Review, which banned commission payments to advisors. But overall costs hardly budged, with adviser fees taking the place of commissions. According to accountants Grant Thornton, a UK investor with £100,000 has only seen a fall in total fees from 2.86% in 2012 before RDR, to 2.56% after the review, once an increase in advisory fees is added in.
Richard Saunders, former chief executive of the Investment Association, said: “Following RDR, adviser fees doubled, as many in the industry forecast at the time. Fees charged by online platforms have risen as well.”
It would be a surprise if the FCA sentenced the industry to directly reduce fees. But many are expecting action to make costs much clearer. Some industry critics say asset managers are getting rich through hidden costs – costs which should be borne by the manager but which are, instead, charged to the fund and act as an invisible drag on performance.
Daniel Godfrey, former Investment Association chief executive and now a consultant to the FCA, reckons “Lack of transparency in pensions costs is a significant deterrent to investment and causes mistrust. This short changes individuals, the economy and society.” The Transparency Task Force, co-founded by Christopher Sier, has set out to shine light on a fraught situation. With half an eye to the FCA review, the Investment Association has set up a task force to produce a transparency standard, which for some funds would be backed up by an independent board of directors.
This idea of having independent directors on some funds, acting as the eyes and ears of the investors, has cropped in a number of conversations as FCA staff have talked with the industry. It’s an echo of the independent governance committees charged with supervising workplace pension contracts by the FCA in April 2015.
One difficult courtroom moment comes on pay. Steadily rising cashflow has nurtured a steady rise in manager bonuses since the credit crisis. According to the Financial News City Pay Survey, pay in fund management is close to levels paid by investment banks.
Neil Woodford, a critic of the complexities of the fund management industry, replaced bonuses at his boutique with fixed pay scales. But Woodford’s initiative is rare. According to Tim Hodgson, a senior investment consultant at Willis Towers Watson: “Asset management is a high-pay, high-margin business and always has been.”
In a book published this year, David Pitt-Watson of the London Business School warned its bonus culture can lead to a search for short-term benefits for employers, rather than long-term value creation for clients.
It can also lead to inertia, according to investment bankers, as managers milk their fees. One private equity manager said traditional firms were stuck in a culture well versed in ways to extract fees from listed bonds and equities. Investment in private assets and alternatives has been restrained, despite their outperformance over 10 years, according to data provider Preqin. A private equity manager said: “It’s all about culture. And you can see why managers want to stick with the sectors that made them successful.”
Another issue the industry has to defend is the high margins some players enjoy. How high? Operating margins average 35%, according to the Financial Conduct Authority. The average of UK listed managers is 40%. Jupiter Asset Management weighs in at 51%. Cedar Rock hits the jackpot with 95%, before partner distributions. In its terms of reference, the FCA says it wants to understand how this wealth has been generated.
Chief executives say in their defence their chunky operating margins have enabled them to build up financial cushions to see them through lean years. Since the credit crisis, the FCA has asked managers to use it to boost their reserve capital.
Still, some chief executives report that the FCA staff are struggling to understand how the industry can make such high margins without damaging client interests. The FCA does not rule out referring the sector to the Competition and Markets Authority if it decides the system is failing. Or it may propose further inquiries, rule changes, general guidance or enhanced self-governance for individual firms or the sector as a whole. It declines further comment, beyond the text of its terms of reference.
However, the terms of reference to the study did indicate that it didn’t see the industry as an oligopoly, stating: “The asset management industry does not appear particularly concentrated.”
The industry’s view is that competition is fierce and that ensures the customer gets good value.
Peter Lenardos, an analyst at RBC Capital Markets, says: “In my opinion, competition is already intense in the sector, and it is hard to see how regulation can further improve competition outside of dramatic and highly intrusive measures.”
The question is whether that competition is only in the area of performance, with rather less competition on fees.
Asset managers get irked over the FCA’s suggestion that fees tend to huddle around the same point, equivalent to 1.5% in 2015, according to Morningstar data quoted by the FCA. One head of marketing said: “We go to great lengths to see what our competitors are charging. We don’t want to charge above the going rate. We don’t want to do ourselves down. So we tend to huddle around the same point. But competition does take place. It derives from the performance we deliver.”
One consultant notes that the issue of fees is thrown into much sharper relief in the low-return environment, in which the investing world, despite eight years passing since the financial crisis, seems to be stuck. Managers conceded that FCA requests for greater cost transparency could not be ruled out. Most think that the FCA will back the Investment Association task force recommendation on greater fee disclosure, with fees being disclosed in easy-to-understand pounds and pence rather than in complex percentages.
Despite the courtroom nerves, chief executives speaking to Financial News on condition of anonymity are fairly confident of emerging from the review intact and, indeed, see opportunities in Brexit and need to be free to compete without being manacled by the FCA. They say exchanges with the regulators have been civil and the FCA has been diligent in gathering data.
They are relieved Martin Wheatley resigned as FCA chief executive in July 2015. He was happy for the FCA to be seen as a consumer champion, once saying he would “shoot first and ask questions later”. Wheatley’s successor, Bailey, is seen as a man to do business with, as much concerned with the stability of the financial sector as the sector’s riches.
There’s a feeling that the regulator at heart understands the industry and is keen to be constructive. For example, they say, FCA has started to ask chief executives to come up with succession plans to maintain their stability.
One executive said he was surprised by the youth of his visitors from the FCA. But he took comfort from the presence of Rob Taylor, former chief executive of wealth manager Kleinwort Benson, and current head of FCA investment management: “He knows the score.”