Many fund management companies are not carrying out adequate reviews of their fund fees, the City watchdog has warned in a damning report on the industry.
Authorised fund managers are required by the Financial Conduct Authority (FCA) to carry out assessments of value (AoVs) at least once a year, calculating whether their fund fees are justified in terms of the value provided to investors.
A review by the FCA between July 2020 and May 2021 found that “too many” fund managers “often made assumptions that they could not justify to us”.
The regulator said this undermined the credibility of their assessments.
Fund managers must report details of their assessments to investors together with a clear explanation of what action has been or will be taken if they find that the charges paid by investors in the funds are not justified.
“When considering a fund’s performance, many firms did not consider what the fund should deliver given its investment policy, investment strategy and fees,” the FCA said.
But it found that firms spent a “disproportionate amount of time” looking for savings in administration service charges, which it said cost investors relatively little compared with the time spent reviewing the costs of asset management and distribution, which the watchdog said typically cost investors much more.
Some fund managers fell short expect by using processes that were poorly designed, which led to them failing to assess elements such as fund performance, AFM costs or failing to perform assessments at share class level.
The FCA said some independent directors on the boards or governing bodies of fund managers “did not provide the robust challenge we expect and appeared to lack sufficient understanding of relevant fund rules”.
When considering a fund’s performance, many firms did not consider what the fund should deliver given its investment policy, investment strategy and fees, a report of the review said, with these firms often assessing the value provided by a fund’s performance by comparing it with the fund’s stated objective, irrespective of whether this objective reflected how the fund was managed, and what the fund’s fees suggested the manager should be trying to achieve.
Some firms said a manager’s style of investing was the reason for their funds’ underperformance relative to a benchmark index for some years, and yet still assessed the funds’ performance as providing value, "even though the manager’s style of investing and the risks of relative under-performance for long time periods attached to it had not been clearly disclosed to investors".
Many managers of funds-of-funds or multi-manager funds only compared value versus other similar funds and had not considered whether there might be better performance measures to assess value, with the report suggesting such managers might instead "consider comparing their funds’ risk adjusted net performance with that of funds that invest only in the markets to which their funds are most exposed".
Fund management companies were called on to assess their process anew and make necessary changes, with the FCA warning that it will reevaluate firms again in a year’s time.
Penalties or other punishments could be forthcoming for those that have not improved in line with expected standards, it was suggested, with the regulator threatening to “consider other regulatory tools” for persistent offenders.
The review was carried out among 18 firms, covering different business models and sizes.
Moira O’Neill, head of personal finance at Interactive Investor, said the reports “have been a huge catalyst for change" since they were introduced two years ago.
For example, she noteds that Schroders has simplified its charging structure, after finding that nine out of 86 funds had not demonstrated value in its first set of reports, while BlackRock, the world’s largest asset manager, moved 14,000 investors into cheaper share classes last year, delivering savings of £3mln.
“With higher standards, we could see even more change, so we welcome today’s statement from the regulator. But we’d also like to see more guidelines on the reporting of value for money statements. They are frustratingly difficult for ordinary investors to find and require journalist-like investigative skills. It need not be so difficult," O'Neill said.
“In the absence of independent boards of directors on open-ended funds, value for money reports have potential to act as a check and balance – but we are not quite there yet.”