Tip of the iceberg: What does the FCA asset manager report mean for the industry?

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The FCA plans to shake up the investment industry after its long-awaited interim report on fund charges found active management fails to justify high fees for lacklustre returns.

The watchdog has put forward a number of reforms for the market, including an “all-in fee” for funds, greater clarity on fund charge communication, better identification of underperformance, and easier switching into better value share classes for retail investors.

Experts have argued the all-in-fee and other measures from the FCA, if enacted, could pose a challenge to the industry and lead to fund closures.

As well as making a number damning remarks about the performance of active funds after charges, the FCA also said it had “some concerns about whether intermediaries deliver value for money”.

Commentators argue this is just the beginning of more scrutiny on advice from the FCA.

Pricing pressure

In its report, published last week, the FCA recognised the “important role” advisers play in retail distribution. £163bn of gross retail sales in 2015 were advised, but the FCA said some developments in sector may affect competition in the space.

This includes adviser networks and vertical integration, the growth of model portfolios as well as third party ratings providers.

Former FCA technical specialist Rory Percival says the study is a “significant” document as he says that – just as with asset managers – there is “very little price competition” in the advice market.

He says: “No advisers really compete on price. Advisers and consumers are completely non-price sensitive around investment and pensions.

“From an economic sense, they need to be the buyers on the clients’ behalf so they need to do that thinking about cost and providing competitive pressures on costs and that is a kind of mindset that I don’t think necessarily all advisers are tuned to.”

Candid Financial Advice director Justin Modray recently stopped recommending M&G and Jupiter funds to his clients over concerns about the groups’ inflated administration fees on their funds.

However he says advisers are probably “the worst overall at providing value for money”.

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He says: “Many financial advisers appear to have used the banning of commission to double their annual fees, from 0.50 per cent commission to a 1 per cent annual fee. They also tend to use expensive investment platforms for their convenience and some add insult to injury by outsourcing the fund management to expensive multi-manager or discretionary services.

“Investors have generally had a rotten deal for years. They deserve better than this and it’s fantastic news that this is finally on the FCA’s agenda.”

But Apfa director general Chris Hannant has hit back at the FCA’s attack on the value for money for advice.

He says: “If you want to look at costs you should look at margins as well. If there was a huge level of profits in this part of the sector then you would expect [the FCA to focus on advice], but since margins tend to be fairly thin…the price reflects the cost of delivering the service.

“The FCA has looked at the supply of the advice market under the Financial Advice Market Review already so to repeat this again 12 months later… I suppose the FAMR didn’t get the right answers.”

Going vertical

The FCA also calls into question whether firms such as St James’s Place, Standard Life, Old Mutual Wealth and Hargreaves Lansdown promote their own funds to advisers for their own interests or the end consumer’s.

The FCA says: “We have been told that the flow of money into in-house funds is growing” citing one adviser network which has increased assets under management in its in-house funds by £1bn over the last 10 months.”

As at 30 June 2016, 26 per cent of Old Mutual Global Investors net flows were through Old Mutual Cirilium portfolios, which is the OMGI multi-asset investment solution available to Intrinsic restricted advisers.

Old Mutual Wealth chief distribution officer Richard Freeman says for vertical integration to work it must offer “quality investment performance” and that “suitable investment solutions are central to ensuring great customer outcomes”.

He says: “We aim to blend capabilities across our business, but the decision about which investment solutions are right for each individual client remains with the adviser, where client suitability decisions will always remain sacrosanct.

“We have robust processes to ensure that when an adviser recommends a fund from Intrinsic’s pre-researched panel of solutions they can have full confidence that it has been researched to an incredibly high standard.”

Assets in HL multi manager funds rose by £700m in the year ending 30 June. Conversely, Standard Life’s restricted national advice firm 1825 has a limit in place so that client portfolios can only hold up to 30 per cent of assets in Standard Life Investments funds.

Percival says the vertical integration focus from the FCA is a “very strong and emphatic reiteration” of some of the key things firms should be thinking about when firms put together the business and the investment proposition.

He says: “One of the things the FCA has always said is that if an adviser is recommending a solution that has a high cost than some other solutions there needs to be a good reason for that and if that good reason is relevant to that client and it is also commensurate with the additional cost concerned.”

Being upfront about fees

While the asset management industry had feared the FCA would put a cap on fees the regulator shied away from the idea with chief executive Andrew Bailey saying such a cap would be a “measure of last resort.”

Since no cap will be put on asset managers fees, Percival says it’d be “inconceivable” to cap advisers’ fees.

He says: “A price cap is a really heavy handed approach so you are only going to use that if really necessary.”

Experts argue the FCA’s solution of an all-in fee may lead to fund closures.

Investment consultant Daniel Godfrey says a combination of an all-in fee and greater transparency on funds’ objectives, measures and timeframes could lead to fund closures because “people would have a much clearer way of judging whether a fund is failing or succeeding.”

No advisers really compete on price. Advisers and consumers are non-price sensitive around investment and pensions

Gbi2 managing director Graham Bentley says: “Business have to pay much more attention to how much costs effect the transaction but [the all-in fee] might not be easy to do. You can see more fund closures if you have an all-in one fee as people will be much less likely to launch new funds which itself might be a good thing.”

Chelsea Financial Services managing director Darius McDermott adds: “There always appears to be more funds opening so it seems to be no shortage of ideas within the fund management community to launch new products but there is also a focus on where there are going to be funds with smaller assets under management, that are not getting traction and maybe are more passive type or core plus type funds charging a reasonably expensive fee.”

What’s next?

Despite FCA’s Bailey saying passive management is not better than active, the regulator’s report has drawn a clear conclusion on where active management fails to give value to clients.

Godfrey says active management has to be more differentiated from passive to prove it is value for money.

He says: “For active to succeed it has to stop trying to beat the market over a relatively short period of time and it has to be confident that if you are an active manager and can’t beat the market over a long period of time then the message is that you don’t have the skill.”

Meanwhile, Percival expects a separate piece of work on advice from this FCA paper which could “tinker” some aspects of advice such as disclosing ongoing charges in cash terms every year.

Bentley says: “The investment industry will work through some of the FCA recommendations but as the Investment Association said, ‘we’ll have a look at this and see how effective [the recommendations] might be’, that doesn’t fill me with confidence.”

Expert view

Jeremy Fawcett
Head of direct
Platforum

At first glance the interim report may give comfort to those with vertically integrated models. It highlights that the FCA has not found abuse of vertically integrated structures in the form of unfair promotion of own-funds.

However, the point of vertical structures is to own more of the value chain and the FCA is correct to identify that this may well create a ‘commercial interest’ to favour own-funds or investment solutions. Given that it thinks that this raises questions about ‘competition dynamics and value for money’ it seems inevitable that further investigation will follow.

This won’t necessarily lead to a clamp down on vertical integration per se – particularly because it can help to deliver the efficiencies that the FCA desires – but more intense scrutiny and guidelines may follow.

Overall, platforms are seen to be enablers of market access for fund managers and the increased prevalence of centralised investment propositions within advice firms is a deliberate effect of the RDR. So in some ways the FCA are supportive of aspects of vertical integration but that won’t stop them from policing it rigorously.