A year before Link became inextricably tied with the Woodford Equity Income fund suspension, it published a blog touting the best governance model for funds. There needed to be “a clear delineation of responsibilities” between investment expertise and fund oversight, its head of client relationships said in the 2018 post.
Thanks to the Woodford fiasco, Link Fund Solutions is now under investigation by the Financial Conduct Authority (FCA) for its oversight, or lack thereof, of the liquidity and compliance issues that resulted in the fund’s suspension.
Meanwhile, the regulator is conducting a thematic review of the entire authorised fund manager (AFM) sector, which is referred to as authorised corporate directors (ACDs) in the case of Oeics. This probe is focusing on the commercial conflicts faced by external providers of the oversight service, rather than the internal function used by most large asset managers.
But the industry says both models have shortcomings.
‘Neither set-up is nirvana in terms of taking the client’s side’
The fiduciary duty of an external AFM such as Link Fund Solutions – to provide fund oversight in the best interests of investors – can clash with the commercial relationship it has with investment managers.
However, the alternative insourced AFM model used by most large asset management companies is not without regulatory risk either. In November 2019, the FCA fined internal ACD Henderson Investment Funds £1.9m for keeping investors in the dark over two enhanced index funds it had transitioned into entirely passive vehicles.
While there is less commercial pressure on the internal ACD, some might question whether an asset management company is best placed to lead independent oversight of its own funds.
“Neither set-up is nirvana in terms of taking the client’s side,” according to investment management consultant Charles Payne, founder of Partners on Demand. “The whole regulatory framework is balanced precariously on the fallacy that the ACD appoints the fund manager. I can’t think of a single case where this reflects the commercial reality of the relationship.”
Link and Woodford relationship highlights commercial conflict
In regulatory terms, Link Fund Solutions as AFM delegated the investment management responsibilities to Woodford Investment Management.
Commercially, however, despite Link being the UK’s biggest outsourced ACD with £96.6bn assets under management, Woodford was one of its largest clients.
It inherited the Woodford Equity Income Fund as part of its 2017 acquisition of Capita Asset Services, a business that had already faced controversy as the ACD for collapsed fund companies Arch Cru and Connaught.
Woodford Equity Income Fund accounts show the ACD periodic charge was £43.3m in 2018, although the ACD pays the depositary, custodian, administrator, auditor and FCA out of this fee, and it is difficult to determine how much of it went to Link.
In 2017, the fund’s assets peaked at £10.7bn and the periodic charge was even higher, at £65.6m.
Link Fund Solutions’ latest accounts, from the period ended 30 June 2019, show its total revenues were £79.4m.
FCA rules could dampen criticisms of insourced ACDs
Several people in the industry told Portfolio Adviser ACD services are often a loss leader to bring in more business for other services such as custody and administration.
“The asset management market study has brought into sharp relief an inherent conflict between the fiduciary role the ACD has to play and the commercial role an external ACD has with a fund manager,” says Fund Boards Council chief executive Shiv Taneja. The FCA’s market study requires all ACDs to appoint at least two independent directors to their boards, effective from 30 September 2019, and the Fund Boards Council acts as a membership body for these individuals.
According to Taneja, the rules should dampen criticism internal ACDs had faced over their lack of independence compared with their external counterparts.
He says outsourced ACDs have an important role to play in helping small businesses enter the asset management space, but believes the current model isn’t functioning.
“If external ACDs are to have a legitimate role in the governance of funds in this country in the future, they’re going to have to bring in much more capability; and to do that they’ll have to increase their fees. There needs to be a sea change in mindsets as you can’t do this for nothing.”
The FCA’s response to the ACDs involved both in the Woodford Equity Income suspension and Janus Henderson’s closet trackers could prompt external providers to increase charges significantly, says Payne.
Alternatively, some players may pull out of the market altogether, believing that the risks involved are not worth the returns.
At the same time, the fact that ACDs are first in line for censure when the FCA deems something has gone wrong could prompt more asset managers to outsource, adds Payne. “It might be that all fund managers will outsource their ACD to a third party, throwing a body between them and the regulator in case something goes wrong.”
Marlborough Group co-managing director Wayne Green says there are asset managers who are bringing the ACD function in-house and others who have always used an internal ACD are outsourcing. The Marlborough range has an internal ACD, while IFSL Fund Services, which Marlborough Group acquired from BNP Paribas in 2012, is an outsourced ACD for a growing range of third-party funds.
“There’s a shift in both directions, which is a good thing,” says Green. “It means people are reviewing what they’ve got.” He says IFSL is used primarily by wealth managers who want to unitise their funds with Tilney and Equilibrium Wealth Management among its clients.
Intermediary due diligence on ACDs is a mixed bag
Even before Link was forced into the spotlight due to its role as the Woodford Equity Income ACD, Green had noticed a lot more due diligence from clients planning to use IFSL as their outsourced ACD.
“In theory, it’s a little bit backwards because we, as the ACD, are appointing them, so we do a lot of due diligence on them. But it’s good because now they are paying more attention to how you operate.”
The rigor of intermediary due diligence on ACDs varies, however.
Green would like ACDs to be treated as an integral part of fund selection, not just a box-ticking exercise. “As much attention should be paid to the governance, oversight, knowledge, experience and strength of the ACD business as is paid to the investment management of the funds, the return, performance and statistical analysis,” he says.
“If someone’s delivering great numbers because they’re being given more freedom than they should be, that’s not a great long-term strategy.”
Morningstar Investment Management EMEA chief investment officer Dan Kemp describes ACDs as critical to ensuring investments are properly managed and expects them to be available to discuss governance issues.
Kemp doesn’t have a preference for an insourced or outsourced model, although the latter should not become too dependent on a single fund or client, he says.
“An outsourced arrangement may benefit from economies of scale that will enable it to provide a competitive service. However, remember that all businesses, including ACDs, need to cover their costs, which may limit savings available to the end investor.”
Damage to Link from Woodford fund
According to Wellian Investment Solutions chief investment officer Richard Philbin, there is now a reputational risk for investment managers using Link Fund Solutions.
“If it was us we would be on the phone to them all the time and we would also be looking at a plan B.”
Wellian uses Valu-Trac Administration Services as an outsourced ACD and had already been stepping up due diligence before the Woodford suspension.
From a fund-picking perspective, Philbin would now look twice at any fund in his portfolios that use Link as the ACD.
If Link loses business due to the Woodford fallout and regulatory pressure prompts more asset managers to outsource, Philbin wonders who would pick up the extra business and if they’d have the right resources.
According to Green, there’s a finite number of people in the industry that have the experience and the knowledge to carry out ACD work well. “You have to be quite specialist in the collectives world. You’ve got to understand the compliance, regulation, investment management, risk, fund accounting and so on.”
Assessing the financial stability of an ACD should become part of the fund selection process, adds GBI2 managing director Graham Bentley, although he says operational issues get overlooked by most fund pickers in favour of the investment case.
“Looking at some of the fund hosting businesses, you struggle to understand how some very small ones are making any money,” he says.
While he expects there will be plenty of firms happy to take business away from Link, he notes it remains the ACD for a number of big names, including Lindsell Train. Nick Train’s £6.7bn UK Equity Fund is now the largest Link product in the Investment Association universe.
