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2017-06-29 06:00:58
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There will be more transparency on charges and better governance standards. But
how much in the fund-management industry will really change?
IMAGINE an industry where the average profit margins were 36%, where the
regulator found little evidence of price competition and where the average
person did not get the benefit of the lower charges available to the wealthiest
customers. You would probably expect the regulator to throw a book the size of
Thomas Piketty s Capital at it. The industry s executives ought to be as
nervous as a very small nun at a penguin shoot.
But that has not happened with the report of the Financial Conduct Authority
(FCA), Britain s regulator, into the fund-management industry, which was
published today. What the FCA proposes in terms of greater transparency of fees
and better governance standards is fair enough. But one wonders how much
difference it will make. The industry has reacted to the findings with
equanimity.
Perhaps the most damning of the report s findings is point 1.9
We find weak price competition in a number of areas of the asset management
industry. Firms do not typically compete on price, particularly for retail
active asset management services. We carried out additional work on the pricing
of segregated mandates which are typically sold to larger institutional
investors. This showed that prices tend to fall as the size of the mandate
increases. These lower prices do not seem to be available for equivalently
sized retail funds
Fund managers benefit from economies of scale; it does not cost ten times as
much to manage 100m as it does to manage 10m. But because they charge an ad
valorem (percentage) fee, managers get paid ten times as much for the former as
for the latter. Institutional investors (pension funds and the like) realise
this and negotiate lower fees for bigger sums. But the same benefits do not get
passed on to retail investors; the little guy. That helps explain why the
industry can earn such high profits.
One reason for this is that investors have not traditionally picked funds on
the basis of price; they are aiming for return. And that leads them to pick
funds on the basis of past performance; money for old hope. Surveys show
(including those in the FCA s interim report) that they are deluding
themselves; performance does not reliably persist.
Another reason is that the cost of fund management may not be clear in
investors minds; it is not like comparing bottles of milk. Some people
struggle with percentages and even for those who do understand them, the cost
in terms of hard currency may not be easily apparent; for a 10,000 investment
the difference between an active fund charging 1% a year and a tracker charing
0.2% is 80 a year.
And the annual fee is not the only charge; some funds trade a lot more than
others and this costs money. So the FCA wants to see an all-in fee revealed to
investors; something that is also under way (as of 2018) under an EU regulation
called MIFID II. (Yes, the EU often passes regulations, as with abolishing
roaming charges for mobile phones, that are consumer-friendly).
Admittedly, this is a complex area. Fund managers may be doing their clients a
service if they trade out of a losing position and the overall impact of
charges will show up in the net return. Hence there will be consultation before
the details of an all-in charge are revealed. Nevertheless, this seems to be an
area where sunlight is the best disinfectant.
Few will disagree either with the FCA s desire to strengthen the duty on fund
managers to act in the best interests of investors and to improve corporate
governance by having more independent directors.
But will this make an enormous change to the industry? If the findings were
about water or power supply, the regulator would have acted a lot more harshly.
However, those industries are natural monopolies and fund management is not.
There is an argument that regulators should accordingly insure that consumers
are better informed and let them choose for themselves.
The biggest impact on the British industry came with the retail distribution
review (RDR) of 2012, which outlawed the payment of commissions to advisers to
recommend funds. The effect of the old rule was to incentivise advisers to
recommend higher-charging funds (since the commission came out of the annual
fee). The effect of the RDR has been to create a distinction between clean
classes of shares (with no commission) and bundled classes. The Investment
Association, the industry s lobby group, says there has been a fall in the
average fee on clean shares from 0.99% to 0.92% in recent years. The FCA report
rightly says it should be easier for investors to switch to the cheaper, clean
classes.
Perhaps the most encouraging development has been the stepping-up of the
presence of Vanguard, the low-cost mutual fund giant, in the British market.
Before the RDR, it was hard for Vanguard to sell funds; now its business is
growing at 25% a year. But it is a sign of the poor competitiveness of the
British industry that Vanguard s market share is much higher in the US. The
remarkable thing about finance, compared with other industries like music or
telecoms, is how long it takes a low-cost operator to shake up the industry.
All index-trackers are not perfect; some charge too much and some indices are
not well-diversified (the MSCI World, for example). But as Warren Buffett
points out, they are the best option for most people. Retail investors can t
rely on the FCA to bring down costs; they will have to do it for themselves.