UNITED KINGDOM: FCA Publishes its Final Report on Asset Management Market

Tuesday June 27 2017

In June 2017, the FCA published its final report on the Asset Management Market study. Earlier, the FCA had launched its market study into asset management in November 2015. The FCA looked into this sector because it wanted to ensure that the market works well, and the investment products consumers use offer value for money. Improvements in value for money could have a significant impact on pension and saving pots.

The UK’s asset management industry is the second largest in the world, managing around £6.9 trillion of assets. Over £1 trillion is managed for UK retail (individual) investors and £3 trillion on behalf of UK pension funds and other institutional investors. The industry also manages around £2.7 trillion for overseas clients.

The services offered to investors involve searching for return, risk management and administration. The investor bears virtually all the investment risk. Over three quarters of UK households are saving for, or receiving, occupational or personal pensions that rely on these services, whether directly or indirectly.

This includes over 9 million people saving for their retirement through defined contribution (DC) pension schemes and approximately 1.4 million savers currently building up pensions in defined benefit (DB) pension schemes. There are also around 11 million savers with investment products such as stocks and shares ISAs. These investors are willing to put their money at risk to generate potentially greater returns than they can get through cash savings.

In November 2016, FCA published its interim report on its Asset Management Market Study. The report considered how asset managers compete to deliver value for both retail and institutional investors. FCA’s interim report found there was weakness in price competition in a number of areas of the asset management industry.

FCA consulted widely on its interim findings and proposed the following remedies.

Price competition

FCA found 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. FCA 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.

FCA confirmed its interim finding had considerable price clustering on the asset management charge for retail funds, and active charges have remained broadly stable over the last 10 years. It had agreed with its respondents who said that, in and of themselves, price clustering and broadly stable prices do not necessarily mean that prices are above their competitive level. FCA also found high levels of profitability, with average profit margins of 36% for the firms FCA sampled. Firms’ own evidence to us also suggested they do not typically lower prices to win new business. These factors combined indicate that price competition is not working as effectively as it could be.

Performance

The FCA looked at fund performance, and the relationship between price and performance. In its additional analysis, FCA found substantial variation in performance, both across asset classes and within them. However, FCA evidence suggests that, on average, both actively managed and passively managed funds did not outperform their own benchmarks after fees. This finding applies for both retail and institutional investors.

The FCA found some evidence of a negative relationship between net returns and charges. This suggests that when choosing between active funds investors paying higher prices for funds, on average, achieve worse performance. Similar academic studies of the US mutual fund industry have typically found a negative relationship between fund charges and fund performance.

It is widely accepted that past performance is not a good guide to future performance. The FCA also found that its difficult for investors to identify outperforming funds. This is in part because it is often difficult for investors to interpret and compare past performance information. Even if investors are able to identify funds that have performed well in the past, this past performance is not likely to be a good indicator of future performance. There is little evidence of persistence in outperformance in academic literature, and where performance persistence has been identified, it is persistently poor performance.

The FCA found some evidence of persistent poor performance of funds. However, FCA also noted that worse performing funds were more likely to be closed or merged into better performing funds. In our additional work, its investigations also found that the performance of the merging poorer performing funds improves after they have been merged. While mergers and closures may improve outcomes for some investors, not all persistently poorer performing funds are merged or closed. It can also take a long time for worse performing funds to be closed or merged.

Clarity of objectives and charges

FCA had concerns about how asset managers communicate their objectives to clients, in particular how useful they are for retail investors. Many active funds offer similar exposure to passive funds, but some charge significantly more for this. FCA estimate showed there are around £109bn in ‘active’ funds that closely mirror the market which are significantly more expensive than passive funds.

FCA considers value for money for asset management products typically to be some form of risk-adjusted net return. This can be broken down into performance achieved, the risk taken on to achieve it and the price paid for the investment management services. Investors’ awareness and focus on charges is mixed and often poor. There are a significant number of retail investors who are not aware they are paying charges for their asset management services

Investment consulting and other intermediaries

FCA has found significant differences in both the behaviour and outcomes of different institutional investors. A number of, typically, large institutional investors are able to negotiate very effectively and get good value for money. However, FCA also see a long tail of smaller institutional investors, typically pension funds, who find it harder to negotiate with asset managers. These clients generally rely more on investment consultants when making decisions.

FCA has identified concerns in the investment consulting market. These include the relatively high and stable market shares for the three largest providers, a weak demand side, relatively low switching levels and conflicts of interest.

More generally, FCA recognises asset managers play a role alongside others in the chain that delivers investment products to consumers. Our analysis suggests that retail investors do not appear to benefit from economies of scale when pooling their money together through direct – to – consumer platforms.

FCA also have concerns about the value retail intermediaries provide.

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