Many years ago, while he was still at working at another institution, the current Rathbone Unit Trust Management chief executive Mike Webb summed up for me his view of the differences between active and passive fund management.
You are in hospital after falling down the stairs at home. Both your legs are encased from hip to toe in plaster. Hardly surprisingly, you are feeling sorry for yourself. Then the consultant comes by on his rounds. “Cheer up,” he says, “the patient in the bed next to you has broken both his legs – and an arm too.”
Mike was describing a situation, shortly after the stockmarket crash in 2000, where fund managers faced telling their clients that the performance of their investments had dropped by up to 20 per cent in value. In such a scenario, being able to compare oneself against a fund that had fallen by 30 per cent held a definite attraction.
The issue for Mike was not about whether some form of benchmarking was necessary. His concern was too many fund managers were simply trying to avoid falling below those benchmarks, rather than focusing on stock-picking skills and delivering the best possible growth for their investors.
For people like Mike Webb, there has always been a strong personal sense of ethos involved in trying to deliver what you promise investors, even if at times you risk underperforming because some of the decisions you took had turned out wrong.
The evidence, sadly, suggests a significant proportion of the fund management industry operates to different standards than his own.
What the FCA is hoping is the fund management industry
will finally engage in a self-regulatory process on charges and transparency it has spent years desperately avoiding
Last week, the FCA published its asset management market study, which found £109bn is sitting in “partially active” funds that charge higher fees than passive funds. Yet they take only “modest positions” close to the benchmark average and their returns are linked to that benchmark.
FCA chief executive Andrew Bailey was quoted in Fund Strategy’s sister title Money Marketing, querying this approach: “There are some active managers that are less active, so we question the fees and the transparency of those fees.”
For FCA director of strategy and competition Christopher Woolard, the issue is not just of excessive charges being levied by managers for not doing very much at all, but of investors being unaware they are paying high fund charges for returns that are statistically unlikely to materialise.
Shorn of all diplomatic language, another interpretation of the FCA’s report is the fund management industry is swindling investors to the tune of at least £1bn a year. This is the difference in the mark-up between what active managers would charge and the passive index-linked funds they are aping.
This collective rip-off involves a private sector job creation scheme on a scale that left-wing Labour shadow chancellor John McDonnell could only dream of, with tens of thousands of people employed to perform tasks any machine could do almost as well. If a cowboy builder were to engage in similar practices, they would take pride of place on BBC Watchdog’s Rogue Traders weekly TV segment. Yet beyond a few polite platitudes and mild murmurs of disapproval no one really seems to be blinking an eyelid.
It is in that context we need to understand the FCA’s remedies to this issue. Bailey told journalists attending the FCA’s press conference that to impose a fee cap on investment funds would be a measure of “last resort”, because it was not an effective way to drive competition in the market.
FCA supervision director Megan Butler added the FCA would only take enforcement action “when there is a breach in this area”.
In a brilliant evocation of Horatio Nelson at the Battle of Copenhagen in 1801, the regulator does not need to do very much at all because it has not identified a breach in its rules. Truly brilliant thinking: used elsewhere, for example with burglary statistics, such an approach could be used to cut crime at a stroke of the pen.
Instead, the regulator is focusing on number of reforms for the market, including an “all-in fee” that takes in all costs, to improve transparency and competition among asset managers. It also wants an overhaul of internal governance standards for investment fund boards to ensure they consider value-for-money issues.
Boards should be comparing equivalent retail and institutional share class prices and considering how to pass on economies of scale to investors – using sliding-scale fee arrangements, for example.
Among improvements to fund charge communication the regulator is suggesting the publication of an annual report detailing how boards are ensuring value for money, including assessments and negotiations on charges.
Hands up anyone who thinks it will work.
At the end of the day, what the FCA is hoping is – against all available evidence – the fund management industry will finally engage in a self-regulatory process on charges and transparency it has spent years desperately avoiding like the plague.
The defenestration a year ago of Daniel Godfrey from his chief executive’s role at the Investment Association for proposing such reforms serves to puncture such optimism. Daniel, who acted as an adviser to this report, is now hoping the industry leopard will change its spots.
Well, in 12 months’ time – and another £1bn lining industry pockets – we will know, won’t we? I am not holding my breath.
Nic Cicutti can be contacted at email@example.com