Fund managers ‘failing their savers’
Watchdog warns actively managed accounts do not beat benchmarks and consultants are ineffective
FUND managers must be clear about how much they charge investors and should end the “price clustering” that is stifling competition and hiding poor performers, the financial watchdog has warned.
The Financial Conduct Authority (FCA) has told fund management firms, which three-in-four British households rely upon to manage their pensions, they must adopt standard “all-in” fees to help investors identify best value for money. Active fund managers, which aim to beat the market rather than simply track its rises and falls, were also criticised over stubbornly high fees for lacklustre returns at a time when cheaper passive funds have cut costs.
“Overall, our evidence suggests that actively managed investments do not outperform their benchmarks after costs,” the FCA said.
Shares in fund management firms Jupiter Asset Management and Standard Life fell 2pc after the FCA’s announcement, although others, including Aberdeen Asset Management and Alliance Trust, held steady.
The FCA noted that margins at asset management firms have stuck at around 36pc over the past six years, regardless of swings in the financial markets or rival offers from passive tracker funds, which have grown five-fold since 2005 and now represent 23pc of all UK assets under management.
The UK’s asset management industry, which is the second-largest in the world, looks after nearly £7 trillion of savings. The watchdog identified £109bn in expensive funds that delivered almost the same returns as a tracker fund.
“In today’s world of persistently low interest rates, it is vital that we do everything possible to enable people to accumulate and earn a return on their savings which can meet their lifetime needs,” said FCA chief executive Andrew Bailey. “To achieve this, we need to ensure that competition in asset management works effectively to minimise the cost of investment.”
Small differences in price can lead to significant losses for investors over time. The FCA said an investment of £20,000 in a fund with the same returns as the FTSE All-Share index would produce £14,439 more over 20 years if the fees were 0.25pc a year plus 0.1pc for transactions, rather than 1pc a year plus 0.5pc in transaction costs. Many active managers cluster around the same prices for their services and the FCA was told that competition on fees rarely brought in new business.
While asset managers have worked on making fees clearer and forthcoming EU rules will require certain funds to explain their offering on three pages, the FCA found that fewer than half of ordinary investors are aware they are paying fund charges. Six in ten investors had never switched provider.
“The investment management industry is committed to serving the needs of the UK’s savers and investors and so we support the FCA’s objectives to ensure that competition in the industry works to the benefit of its customers, whether individuals, families or institutions,” said Chris Cummings, chief executive of the Investment Association. “Over the coming weeks, we will engage closely with the FCA to understand its findings and the full implications of potential remedies.”
The FCA’s year-long study also found that investment consultants used by pensions can come with conflicts of interest and “are not effective” at spotting the best fund managers. It is considering referring these consultants to the Competition and Markets Authority, in the first use of this power.
The watchdog will make its final recommendations, including potential enforcement action or referrals for further investigation, in February.
‘Most funds that genuinely seek to beat the market fail to do so’
For capitalism to work properly, individuals and families need to be able and willing to take their destinies into their own hands. Retail financial services are key to a modern consumer economy and to building a successful, grown-up ownership society: their marketplace needs to be competitive, with low barriers to entry, and their products need to be used and understood by the entire population. Consumers must be encouraged to fight for the best deal, to plan for the future, to think ahead; they need to be empowered to do so by clear information and a strong rule of law.
We are not there yet, and that’s an economic as well as a social problem. There still isn’t enough transparency, especially when it comes to fees, which are often preposterously high for a lousy performance. Consumers don’t always realise that they are getting ripped-off and aren’t therefore putting enough pressure on managers who aren’t giving them good enough value for money. Companies need to up their game – but so do consumers.
One issue is that we have as a society turned our back on the key doctrine of caveat emptor: let the buyer beware. This is a fundamental principle without which capitalism cannot work: it states, quite simply, that we need to be responsible for our actions. We need to return to this – but that requires a massive programme of financial education, especially among young people. It is a scandal that so few people understand the difference between real and nominal returns or can explain the principle of compound interest. Take the UK’s asset management industry: it manages £7 trillion of institutional and individual assets; the vast majority of those with occupational or personal pensions use their services.
Yet the Financial Conduct Authority has just found that price competition is weak when it comes to active funds. The price of passive funds has fallen but active prices haven’t. One problem is that, as the FCA notes: “Investors are not always clear what the objectives of funds are, and fund performance is not always reported against an appropriate benchmark.”
For once, the Financial Conduct Authority’s findings seem reasonably fair, even if I don’t necessarily agree with all of its remedies. The organisation has changed for the better since Andrew Bailey took over; it seems genuinely interested in making the market work better, rather than bashing financiers, closing the stable door after the horse has bolted or throwing its weight about randomly.
The FCA suggests a strengthened duty on asset managers to act in the best interests of investors, an “all-in fee” to make it easier to gauge the size of the cost of employing a manager, and others measures to help investors identify the most appropriate fund.
The “all-in” fee makes a lot of sense: the greater the clarity for investors, the better. We need as much transparency as possible to allow consumers to make more informed and better choices. The alternatives are terrible – caps on fees are always a bad idea. Price controls never work: better allow companies to charge what they want, but make sure that everybody knows exactly what that is and make it easier to switch supplier.
But there is one important paradox that no FCA review will ever solve. Most funds that genuinely seek to beat the market fail to do so, which means that the fees charged are a waste of money (a tiny minority do outperform, of course, and their fees are worth it many times over). For most people, it would make sense instead to put their cash in an ultra low-cost tracker fund. But there is a fatal catch: if everybody played that game, and tracked an index unthinkingly, this strategy would implode. The indices would cease to have any meaning, and share prices would end up disastrously out of whack with reality.
Markets are a process of discovery: the fact that so many people are desperate to beat the market and believe that they can do so is the reason why prices are so efficient at reflecting information, and the market so hard to beat consistently.
The race to super-returns may be unwinnable for most investors – but we should all be grateful to the brave souls who continue to defy the investment odds.