FCA value for money proposals set to deal with orphaned funds

Value and benchmark rules set to create ‘perfect storm’

The Financial Conduct Authority’s (FCA) requirements for asset managers to publicly state how their funds are offering value for money for end investors is likely to result in a cull of sub-par products, industry figures believe.

The regulator found as part of its asset management market study that authorised fund managers generally do not consider robustly whether they are delivering value for money and subsequently from 30 September fund groups have to comply with a value assessment by matching their products against seven criteria.

At the same time, fund groups are required from 7 August to clarify their fund objectives and use of benchmarks, creating a perfect storm of regulatory compliance.

Industry figures believe the added scrutiny funds will be under by fund boards is likely to flag up problem funds that have been languishing unattended for too long – those that have performed badly for too long, have a low AUM and have low flows, or a combination of all three.

Square Mile Investment Consulting and Research commercial director Steve Kenny (pictured) believes the combined effect of value assessments and clarifying fund objectives will lead asset managers to review their fund ranges and question the existence of those not up to scratch.

“This will not be an overnight event, but over the next three to five years I expect to see an increase in fund closures/mergers and manager changes as groups seek to address funds which are not delivering ‘value’,” he says.

Europe’s orphans

Research conducted by Morningstar earlier this year identified a clear performance issue with ‘orphaned funds’ from across Europe, concluding the industry has “far too many funds that are unwanted by investors”.

It found nearly 25% of its total funds’ universe can be classified as orphaned funds – funds that have at least a five-year track record but have AUM under €100m and net in/outflows of less than €10m in each of the past five calendar years.

The median orphaned fund size was just €16.6m (£15.2m) and just 21.8% had a positive rating. Nearly a third of them held Morningstar’s negative rating and of these, 54.3% were fourth quartile based on their five-year returns from 31 Dec 2007 to 31 Dec 2012.

Morningstar UK director of manager research ratings Jonathan Miller told Portfolio Adviser that orphaned funds, by definition, generally appear “structurally impaired”.

Miller adds: “Any inroads that the upcoming measures can make into signalling that investor outcomes are being affected, would be a welcome development.”

On Thursday Aegon cited small size and poor performance as the reasons it will close the Aegon Merian Global Strategic Bond fund in October and move remaining investors into the Scottish Equitable Kames Strategic Bond fund.

The group said: “The Aegon Merian Global Strategic Bond fund hasn’t grown as we’d expected, which means it’s too small to be economically viable. As a result, we’ve decided to close the fund.”

In March, M&G merged the M&G Fund of Investment Trust shares into the M&G Managed Growth fund because it had gained little traction with its customers in recent years. The company says it regularly reviews its fund range to ensure it is reflecting customers’ preferences.

Visibility at board level

Kenny notes the fundamental change from current practice is that the independent non-executive directors (Ineds) and chairpersons will be required to consider the fund in the context of what is being delivered from the consumer’s perspective. Boards are then required to sign off each fund’s value assessment four months after the fund’s year end. Given this comes into force at the end of next month, the first assessments are due at the end of January 2020.

“The evaluation of each fund against the list will lead to the identification of problem funds,” says Kenny. “Undoubtedly, two of the key areas of assessment are performance and cost, ie underperforming relative to revised/clarified fund objective and expensive funds relative to the identified peer group/IA sector comparisons.

“These reports are to be reviewed at board level and the output will be recorded, so there will be visibility at the board level and a need to address those issues.”

Flexibility for fund groups

UK Fund Boards Council founder and chief executive Shiv Taneja says despite some negativity from some fund managers towards the measures, there are positives to be taken, particularly the fact it will allow fund groups to explain the value they are providing in their own words.

Taneja says: “This document has to be made available to the end investor, or certainly has to be made public, so it’s not something that just gets reviewed by the board and then gets filed away in the bottom drawer of a cabinet and not to be seen again for another 12 months.”

Another potential benefit is the non-prescriptive nature of the seven criteria, which means fund groups have free-reign to interpret value as they see fit.

“I actually think it gives them the ability to be intellectually creative, about how they position their outputs on assessment of value,” he adds.

But could the fact the assessment is open to interpretation mean some fund groups just do the bare minimum? Taneja does believe there will be firms that don’t initially want to put their heads above the parapet, but he feels the process should evolve. It will, however, take a few years.

“The first reports that will start coming out in November, December into January, are not going to be the finished article. My hope is that we won’t coalesce to the bare minimum, but we will coalesce to something that will resemble what good looks like.”

Europe could learn from the UK

Taneja suspects that there are far more orphaned funds in the pan-European market than in the UK-domiciled market. He notes that if assessment of value works in the UK, and it starts to deliver, it could spread to Europe. The European regulator Esma, he says, is already talking about value for money across the pan-continental fund space.

“When that happens we have a game on our hands, we then have a real game-changer opportunity. We’ve got 1,600 mutual fund companies with 33,000 mutual funds across the cross-border marketplace. Do we really need that many? The answer has categorically got to be no. But we’ve got this weird industry of ours that finds it more difficult and more expensive to close funds down than to open them.”

In contrast, he says the US has some 7,500-8,000 mutual funds despite the overall marketplace being much larger than Europe. “They are larger funds, better economies of scale, and as a result, are able to provide a better value from a cost perspective,” he says.

Taneja also says a lot of large UK-based cross-border managers are thinking about doing value for money assessments, not just for UK clients as required but also for cross border fund clients as good practice.


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