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2016-11-29 09:50:41
A new report indicates that investors interests are inadequately safeguarded
Nov 26th 2016
BANKS tend to grab the headlines when it comes to financial scandals and
systemic risk. But many people have a lot more money squirrelled away with the
asset-management industry, in the form of pensions and lifetime savings, than
they do in their bank accounts. A new report* from one of Britain s regulators,
the Financial Conduct Authority (FCA), suggests that the industry is not doing
a great job at looking after investors interests.
The British fund-management industry is huge, with some 1,840 firms managing
around 6.9trn ($8.6trn) of assets. With the ten biggest fund managers
representing only around 47% of the market, competition ought to be pretty
intense. But the FCA report finds that fees in the actively managed sector (ie,
funds that try to beat the market by picking the best stocks) have barely
shifted in the past ten years. Operating margins across a sample of 16
fund-management firms have averaged 34-39% in recent years, one of the highest
of any industry. Profits that heady smack more of an oligopoly than of a
cut-throat battle for business.
There is one part of the market where fees have come down passive, or tracker,
funds that try to match an index. Their fees have fallen by more than half
since the turn of the decade. Passive funds are gaining market share but not as
quickly as you might expect. One reason may be the reluctance of financial
advisers to recommend them. The FCA found that passive funds did not feature at
all on the main best-buy lists of advisers before January 2014 and still
comprise fewer than 7% of the funds on such lists.
The underlying problem, at least when it comes to retail clients, is that fund
managers do not compete on price at all. Part of this is due to many investors
ignorance. Remarkably, more than half of retail investors surveyed by the FCA
did not know that they paid charges on investment products. Surveys show that
many people are hazy about percentages or basic concepts such as compound
interest.
Instead, fund managers seem to compete on the basis of past performance, with
some 44% of retail investors saying this was an influential factor in picking a
fund. Advertisements for funds often highlight the stellar returns previously
achieved.
Launch enough funds (around 36,000 are available across Europe) and some are
bound to be successful. Asset managers simply bury their failures. Of the
equity funds available to British investors in 2006, only about half are still
around in 2016; the others were merged or liquidated. As the report remarks:
This may give investors the false impression that there are few poorly
performing funds on the market.
In chasing performance, investors are pursuing a chimera. The FCA finds, like
others before it, that active managers underperform the index after costs (see
chart). And it finds little evidence of persistence in outperformance. It
looked at the best-performing quartile of funds over the 2006-10 period and
examined how they performed in the next five years. Just under a quarter stayed
in the highest quartile, exactly what chance would suggest. More than one-third
of the stars of 2006-10 slipped to a bottom-quartile ranking or were closed or
merged.
It is hardly surprising that, if investors seem unconcerned by cost, charges
stay high. But it makes a big difference to their wealth. Over 20 years, the
FCA calculates, an active manager s charges can eat up a third of an investor s
return.
Each investment company contains an authorised fund manager board whose aim
is to ensure that the fund meets its regulatory and legal responsibilities. But
board members are employees of the firms they are monitoring and, the FCA
notes, generally do not robustly consider value for money for fund investors.
It is in the interest of asset managers for funds to grow as large as possible,
since they earn a fee based on the size of the fund. There are economies of
scale associated with managing a large fund but the report found that these
savings were not passed on to retail investors. That is just one example of how
no one seems to be looking after the client s interests.
All in all, this interim report points to a litany of failings in the industry.
Yet the FCA s suggested reforms strengthening the duty of managers to act in
the interests of all investors, for example may turn out to be quite modest in
scale. If this were any other industry (electricity generation, say) the public
would demand more robust action. The FCA should wield a bigger stick.
http://www.economist.com/news/finance-and-economics/
21710810-new-report-indicates-investors-interests-are-inadequately