Are funds passing the value-for-money test?

Fund firms have to demonstrate value for money across their fund range. Is this a box-ticking exercise or has it promoted positive change? Danielle Levy investigates.

It has been 19 months since the financial regulator introduced a requirement for asset managers to demonstrate how each of their funds provides investors with value for money.

These so-called Assessment of Value (AoV) reports outline whether value is being provided to the end-investor across a number of metrics such as fees, costs and performance. They also consider whether the fund, structured as either a unit trust or open-ended investment company (Oeic), is priced competitively in comparison to peers and whether investors are benefiting from economies of scale. If areas are identified where asset managers are falling short, action should be taken.

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The Financial Conduct Authority (FCA) hopes these annual reports will be jargon-free, easy to understand and publicly available. They are intended to make asset managers more competitive and accountable to their customers, while assisting private investors who are selecting funds or monitoring existing investments.

The good news is that, so far, AoV reports appear to have been a catalyst behind a number of positive trends. There are instances of fund management groups cutting fund charges, closing poor-performing funds, and moving investors into newer, cheaper share classes.

For example, Schroders found that nine out of 86 funds had not demonstrated value in its first set of reports. They include its Schroder European Smaller Companies and Schroder UK Alpha funds, which have been placed under review. In addition, the group moved 26,000 investors to cheaper share classes and cut charges on 15 funds. Since then, Schroders has simplified its charging structure by introducing an all-in charge that incorporates third-party fees, such as those charged by the administrator and custodian.

Meanwhile, BlackRock, the world’s largest asset manager, moved 14,000 investors into cheaper share classes last year, delivering savings of £3 million. It said that only one of its 121-strong fund range had not consistently delivered value in its first set of reports, contributing to the decision to close the fund last August. The group found that 109 of its funds provided value with no further action required, while a further seven delivered value but improvements were identified. The remaining four were deemed too new to judge, with track records of less than one year.

Falling short

Although the first round of AoV reports represent a step in the right direction, a number of shortcomings have been identified. The CFA Society of the UK said the standard of the reports varied substantially, with a significant proportion simply not “up to scratch”. Nearly a quarter of reports did not clearly outline the strategy’s investment objective, while 42% did not include the fund’s ongoing charges figure (OCF).

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In addition, the CFA said the majority of reports left out key information that retail investors could find useful. More than three-quarters did not mention whether the fund incorporated environmental, social and governance (ESG) criteria, 62% failed to mention risk and 87% did not refer to liquidity.

What’s more, the CFA’s working group could only locate three-quarters of the reports online, causing some to question whether their impact had been muted, given they had not necessarily reached their intended audience of private investors, as well as financial advisers and wealth managers.

Catalyst for change?

This brings an important question to the fore: do AoV reports have the potential to become a force for change or will they merely act as a box-ticking exercise for asset managers?

Mike Barrett of The Lang Cat, a consultancy, describes the first set of reports as a positive move, particularly given their potential to improve transparency on the impact of costs and charges on returns. However, he says there is progress to be made.

“Generally, any kind of reduction in charges is going to benefit investors. But I think as it stands, it feels like it hasn’t quite had the impact the regulator was hoping it was going to achieve. There is always that fundamental point that you are asking asset managers to mark their own homework,” he explains.

Barrett suspects the regulator was hoping to see a certain level of introspection and self-challenge from fund management companies, which is yet to come through – particularly in the reports where 99% of funds were found to have offered value.

His sentiments are echoed by the Investment Association, the trade body for fund management groups. It pointed to improved competition in the industry, but said there was still much to learn from the first set of reports.

“Value assessments are an important tool for ensuring funds are offering value to investors and it’s vital we get them right. After this first year of reporting, there are inevitably lessons to learn,” a spokesperson said.

As asset managers prepare to publish their second set of reports, Barrett would like to see shortcomings that were previously identified rectified, with an assessment of whether the action taken has been effective. He hopes independent directors, who now make up 25% of a fund firm’s board, can improve accountability in this respect.

Barrett adds that confusion has reigned among asset managers because the regulator did not clearly define who these reports were intended for – private investors, or financial advisers and wealth managers? This helps to explain why some reports were written for a professional audience, while others were designed for private investors.

Research produced by The Lang Cat indicates that the first set of value assessments gained very little traction with financial advisers. Only 6% of a sample of 560 advice firms had seen or used an AoV report versus 46% who had not. Meanwhile, 27% were not even aware of them.

Changing behaviours

Steve Kenny, commercial director at research firm Square Mile, says the best way to influence the behaviour of asset managers is to affect the flows into their funds. This can be done only if a broader audience of private investors, advisers and wealth managers engage with AoV reports.

“I think if greater attention was paid to them, this is how you start to change behaviour,” he explains.

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Part of the problem, in Kenny’s opinion, is that the FCA did not provide a template for the reports, so it will take time for an engaging and effective format to emerge. This helps to explain why the quality of the reports varied so much last year. Nevertheless, he says it would be “unforgivable” to see a repeat of some of the mistakes that were made the first time round.

While some asset managers embraced the value assessments and made them easily accessible on their websites, he pointed to examples where it felt almost impossible to locate them. In his opinion, this potentially tells you something about the culture of the business.

Looking ahead, he expects to see continued pressure on the pricing of larger funds. “It is clear the regulator does not feel that economies of scale are being passed on as much as they could be,” he added.

Graham Bentley, managing director at consultancy gbi2, suggests the starting point was for some asset managers to “validate their positions” in the first set of reports, which means the full scope of action that could have been taken wasn’t in some cases.

“There is a lot of spurious information being given out to demonstrate value. At the end of the day, have you delivered what you promised?” he asks.

He expects the second set of AoV reports will be more critical, as independent directors step up to the plate and senior staff realise they are personally accountable under rules called the Senior Managers Regime.

“The Senior Managers Regime means there is more accountability, which means marketing teams are less likely to get away with being overly positive and fund managers are able to explain away bad performance because it was the market’s fault,” Bentley says.

“I suspect in the next round we [will] see rather less comfort associated with just sending any old thing out. Companies will be more appreciative that between now and the next value assessment they have to get a grip on underperforming or less valuable funds,” he says.

The path ahead

In spite of the teething problems associated with the first set of AoV reports, he was encouraged to see instances where underperforming funds were closed and charges were cut.

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He hopes AoV reports will become a useful document for investors in the future rather than a box-ticking exercise for the asset manager. In his opinion, the main way that this will happen is for forward-thinking groups to make difficult admissions and realise that, ultimately, client satisfaction and loyalty are key.

Bentley would also like to see reports presented in an engaging and succinct way, free of jargon and featuring helpful infographics. He says this will increase their potential to become a useful report for investors and intermediaries, rather than a dense regulatory document that gets less traction.

Daniel Lockyer, a senior fund manager at Hawksmoor Investment Management, suspects value assessments can drive positive outcomes in the future. “It should give everyone confidence that there will be fewer zombie funds than there were,” he concluded.