FCA market study: All-in fee might not be all-in cure

The interim report of the study found £109bn of pension money being invested by active managers in strategies that closely follow indices at high cost, suggesting fundamentally poor-value delivery to schemes and savers.

Managers were further criticised for not passing on benefits of scale to their clients, and investment consultants were shown to be largely unable to identify outperforming managers.

If your consultant is conflicted then you do need to get an independent review

Andrew Parker, Law Debenture Pension Trustees

Proposed solutions included a market investigation reference to the Competition and Markets Authority to address conflicts of interest in investment consultancy, and pooling of pension schemes.

An all-in standardised fee and a duty of care for managers were also recommended.

Targeting transparency

There is now an established consensus behind the need for greater transparency in asset management among pension schemes and their advisers.

However, experts warned that the way in which transparency is boosted could be critical to the success of the FCA’s final recommendations, to be published in Q2 this year.

“We need to disclose the right information in the right way to empower and enable the user of that information to make an informed decision,” said Richard Dowell, head of clients at fiduciary management business Cardano.

He warned of the potential for confusion if disclosure is not standardised, or if too much information is provided to trustees.

Dowell also said that placing a duty of care on managers, and closely defining what is a successful outcome, would help schemes and members identify value for money.

One fee is not the answer

The interim report suggested an all-in fee structure, where managers take responsibility for any extra costs incurred.

However, concerns were raised about the cost disincentive to managers making necessary trades, and as Danny Vassiliades, managing director at Punter Southall Investment Consulting, pointed out, the difficulty of predicting costs.

“It’s difficult to promise one overall cost at the outset,” he said, preferring a standardised disclosure of expected costs and actual costs.

The release of the interim report capped off a torrid year for active management as an industry, with belief in benchmark-beating ability faltering.

“The managers are in a tricky spot because the data do not support the idea that active management as a whole adds value,” said Vassiliades.

But despite poor performance on average, Dowell said that good manager selection skills would still be able to pick out alpha.

More problems with fees

For Wolfram Klingler, managing partner at fees specialist XTP Implementation Services, the key problem with current fee structures is the inbuilt incentive for managers to attract more investment.

That results in “super-sized composites with mediocre performance, which for equity strategies generate excessive slippage costs for clients due to their large size and provide extreme economies of scale to asset managers”, Klingler said.

XTP analysis showed that as the size of transactions in a fund increases, so too do market impact costs.

The FCA’s report also highlighted that the economies of scale seen in large funds are not, in general, passed on to savers, with fees remaining at a similar level.

“This is especially disturbing given that investors have to shoulder the negative scale effects in terms of transaction cost,” said Klingler.

Trustee responsibility

The final publication will also seek to address perceived problems with the relationship between schemes and their consultants.

While some consultancies are already registered with the FCA, consultants are currently free to choose their own regulatory framework.

The FCA expressed its concern that consultants have conflicts of interest around recommending services to clients, particularly where fiduciary management tenders are concerned. It has suggested that consultants’ regulation by the FCA could be mandatory.

Andrew Parker, director at Law Debenture Pension Trustees, welcomed this proposal, but added that trustees had a duty to perform proper checks before entering into a fiduciary management contract.

“It’s important to do a proper tender exercise and have a number of people coming in, and if your consultant is conflicted... then you do need to get an independent review,” he said.