In 2018, the FCA introduced new rules requiring UK authorised fund managers (AFMs) to review the value that their authorised open-ended collective investment funds deliver to investors. This week the FCA published its first review into the impact of this Assessment of Value (AoV) reporting, having evaluated the reports of from "18 groups of varying size and business models."
Our Regulations Manager Mikkel Bates takes a deeper look at some of they key points and which areas were highlighted as areas for improvement.
The FCA was not impressed by the Assessment of Value (AoV) reports it analysed, or by the answers it received from those who produced them.
While the Asset management Market Study that introduced them was deliberately not prescriptive, the requirements for each of the seven criteria that make up the minimum assessment are pretty clear in COLL 6.6.21R (shown against each criterion below).
The FCA says in its review that it expects each of the seven criteria to be assessed independently in the AoV reports and its review took the same approach.
- Quality of service: “The range and quality of services provided to unitholders”
COLL 6.6.22G also says that this “assessment … may include services undertaken on [unitholders’] behalf by the AFM, such as consideration of the quality of the investment process”.
The FCA’s criticisms include that some firms only considered the quality of service based on performance or at a firm level, although it acknowledges that many firms satisfied the requirements of COL 6.6.22.
Intangible metrics (trust in the brand), absence of negatives (low level of complaints or breaches) and unjustifiable claims (higher fees for ESG) were also among the criticisms.
- Performance: “The performance of the scheme, after deduction of all payments out of scheme property as set out in the prospectus... Performance should be considered over an appropriate timescale having regard to the scheme’s investment objectives, policy and strategy”
COLL 6.6.20R states that “the AFM must [consider each criterion] separately for each class of units in a scheme”.
Despite a need to assess performance for each share class net of fees, the FCA found some groups used gross returns or only assessed the cheapest share class, but the strongest criticism was aimed at active managers of funds whose objective is as vague as “capital growth”. Achieving a positive return in rising markets, while underperforming the comparator benchmark, was not deemed a justification for higher fees than passive funds.
Two other practices were also picked on – blaming an out-of-favour investment style for long-term underperformance without a plan to do something about it, and comparing funds of funds or multi-asset funds against a universe of similar funds rather than single-asset funds without the additional fees.
Amongst all that, the FCA did praise those active managers who changed their fund objectives from capital growth to “challenging but fair” outperformance targets.
- AFM costs – general: “In relation to each charge, the cost of providing the service to which the charge relates, and when money is paid directly to associates or external parties, the cost is the amount paid to that person”
US-owned groups were praised for using their experience of reporting under the 1940 Act, where they have a long history of justifying their contractual fees.
But this was followed by the inevitable “however…” …many firms failed to justify each charge, as required, simply comparing their overall fund charges to those of their competitors.
Here the FCA showed its true colours, by making it clear that the status quo in terms of profit margin was neither a good place to start when assessing value nor consistent with competitive outcomes.
Instead of basing assessments on either the group’s or the industry’s average profit margin, the FCA expects more attention paid to the fees charged in comparison to the costs incurred in managing the funds.
- Economies of scale: “Whether the AFM is able to achieve savings and benefits from economies of scale, relating to the direct and indirect costs of managing the scheme property and taking into account the value of the scheme property and whether it has grown or contracted in size as a result of the sale and redemption of units”
Again, US firms were praised for good practice, based on their experience, and European businesses were also mentioned in dispatches.
Criticisms on this criterion were for the overuse of subjective or unjustifiable metrics, or for reliance on the market rate as an indicator of value, rather than actual costs incurred.
- Comparable market rates: “In relation to each service, the market rate for any comparable service provided:
(a) by the AFM; or
(b) to the AFM or on its behalf, including by a person to which any aspect of the scheme’s management has been delegated”
The FCA notched up a win on this one, citing a group that has changed a fund’s strategy (and fees) from active to passive, based on an internal value comparison.
The review noted several fee reductions as a result of market comparisons, but it also noted a reliance on lower-charging share classes to show how value was being provided, instead of assessing every share class.
6 Comparable services: “In relation to each separate charge, the AFM’s charges and those of its associates for comparable services provided to clients, including for institutional mandates of a comparable size and having similar investment objectives and policies”
The FCA was not impressed that some groups pushed back against a comparison between retail pooled and institutional segregated fees without any attempt to justify the magnitude of the fee difference, but a few firms scored well on this metric.
7 Classes of units: “Whether it is appropriate for unitholders to hold units in classes subject to higher charges than those applying to other classes of the same scheme with substantially similar rights”
The FCA noted good progress from some groups on bulk transfers of clients into cheaper share classes, but (there’s always a “but”) some firms were criticised for not comparing the charges of their entire share class range, regardless of investment amount or distribution channel, as long as they have “substantially similar rights”.
The role of independent non-executive directors
While the quality, knowledge and engagement of some independent non-executive directors (iNEDs) was acknowledged, the FCA was not impressed by those iNEDs who could not demonstrate knowledge of the AoV requirements, didn’t show that they represented the interests of investors, or even came across as “antagonistic towards the aims of the AoV process”.
The review suggested groups should look at others’ reports for examples of good practice and make changes to their own where necessary. As a believer in full disclosure, it is no wonder the FCA was not persuaded by protestations that investors already have too many over-long reports to digest.
Interestingly, the FCA pointed out that the audience may not always be the end investor, but other stakeholders who make their own assessments of fund value for investors. Anecdotally, the main readers of AoV reports have been competitors, journalists and campaigners against active funds and their fees. This review will give all of them something to add to their armoury.
With little in the way of prescription and a lot to consider in the first set of assessments – particularly for those with a fund year end that put them near the front of the queue, with little or no precedent – it’s no surprise the FCA found cause for complaint, but it is a little surprising that so many criticisms are for failures to meet the requirements clearly set out in COLL. It’s no wonder the report card says “could do better”.
The FCA has said in the past that it is not a price regulator, but that it favoured greater transparency as the tool to drive competition and hence price pressure. This review shows that it has moved beyond that stance, as it seems that transparency alongside self-justification of fees has little impact on competition. So it is out to shake up the old order and drive charges down to something nearer what it costs groups to manage funds.
Another review will be undertaken in a year to 18 months and the FCA expects firms to have taken on board its comments, with the threat of “other regulatory tools” if they don’t.