The Financial Conduct Authority has received mixed reviews on the steps it has taken to curb closet tracking in the years since Henderson Global Investors first admitted it had been overcharging retail investors for a passive fund.
The FCA this month fined an internal authorised corporate director at Janus Henderson £1.9m for two closet trackers, which charged retail investors up to 1.5% over a period of five years before the situation was rectified in early 2016.
In the period since, the interim and final asset management market studies have been published with rules and guidance now largely in force. Governance for ACDs has been tightened and funds are now required to be more explicit about their benchmarks.
But critics argue the FCA still lags regulators in some European jurisdictions when it comes to addressing closet tracking.
Investors still in the dark about FCA closet trackers list
AJ Bell head of active portfolios Ryan Hughes points out Janus Henderson is one of a number of firms caught up in the regulator’s scrutiny of closet trackers, but investors are in the dark about which other firms are involved.
Janus Henderson is one of two firms facing enforcement action. But in total 64 firms were forced to make it clearer to consumers “how constrained” they were. The offending funds were made to stump up £34m in compensation for overcharging.
Hughes argued it is in the public interest if firms are not fulfilling obligations and are being forced to put things right for clients “particularly when it prompts an industry-wide comment from the regulator”.
The UK lags other jurisdictions in addressing the issue, he says, pointing out both Norway and Denmark require funds to publish their active share every year.
In November 2016, the Swedish regulator publicly shamed 25 active funds for too closely replicating the index.
FCA should require active share disclosure
SCM Direct co-founder Gina Miller (pictured) highlighted the gap between the FCA and European regulators in her firm’s report into closet tracking from 2015.
It argued 36% of funds were closet trackers based on those that had an active share smaller than 60%.
Miller remains dissatisfied with the FCA’s response to closet trackers, stating funds should be required to disclose all holdings quarterly, clearly state in marketing materials if they resemble an index fund, disclose active share on factsheets and reflect active share more fairly in fees.
Hughes too would like to see funds required to disclose active share, although he says that figure alone is too simplistic to decide if a fund is good or bad.
He says: “Even a low active share may not be bad as it may be a conscious decision by the fund manager to be close to the benchmark for the time being due to the lack of clear opportunities. In an ideal world I like to see active share figures above 70% but I’m comfortable if it is below this level if I understand why the fund manager is positioned as such.”
Henderson directors would have been more responsible under SMCR
But GBI2 managing director Graham Bentley reckons the fine indicates the rules and guidance from the asset management market study are now starting to have some effect.
Governance changes mean fund boards must now publish a value for money assessment each year in every fund’s annual report. Each fund board must also appoint two independent non-executive directors.
Henderson directors would have “got it in the neck directly” under the new rules, says Bentley, thanks to the senior managers and certification regime (SMCR).
“I think it is likely that the new regime will encourage board members to look at not only current issues, but ask around whether there are any issues that are lingering, that started before the regime takes effect that might still be unresolved,” he says.
Lang Cat consultant Mike Barrett reckons the act of pulling together a value for money assessment will mean the issue of closet tracking is forced on directors every 12 months.
Fund governance changes are just box-ticking exercises
Investment management consultant Charles Payne, founder of Partners on Demand, says the fine is a “hugely significant signpost” from the regulator as to how it expects things to operate once value for money comes into effect.
“The VFM initiative should increase the likelihood of this type of issue being surfaced – although here it does appear that there was already more than one attempt internally (by the internal investment and risk and global product strategy committees) to highlight the issue which were effectively sat on and suppressed within Henderson,” Payne says.
Miller calls the value for money, independent directors and the SMCR box-ticking exercises. “They are onerous administrative costs that detract from the simply, effective solution of holdings transparency which would practically lead to increased informed choice and thus increased consumer protection.”
Likewise, she is sceptical of FCA rules requiring funds to be more specific about their use of benchmarks, requiring these to be consistently referenced across fund literature and used as comparisons in any performance data used for marketing.
She says the investment industry “always manages to avoid the spirit of the rules through its own ingenuity” and most investors never read long legal documents “to which the FCA appear obsessed”.
