The UK financial watchdog Financial Conduct Authority (FCA) recently released a stinging report on the domestic asset management industry that cites underperformance, weak price competition, high levels of profitability, and poor communications with clients.
The FCA said that when looking at fund performance for both retail and institutional investors, it found that both actively managed and passively managed funds did not outperform their own benchmarks, after fees.
“There is no clear relationship between charges and the gross performance of retail active funds in the UK,” said the report, although it did find 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.”
It also said there is little evidence of persistence in outperformance, “and where performance persistence has been identified, it is persistently poor performance.”
The FCA also expressed concern over how asset managers communicate their objectives to clients, particularly for retail investors.
“We find that many active funds offer similar exposure to passive funds, but some charge significantly more for this,” said the report. “We estimate that there is around £109 billion ($141.4 billion) in ‘active’ funds that closely mirror the market which are significantly more expensive than passive funds.”
The FCA report cited “weak price competition in a number of areas” of the asset management industry, and high levels of profitability, with average profit margins of 36% for the firms sampled.
“Firms’ own evidence to us also suggested they do not typically lower prices to win new business,” said the report. “These factors combined indicate that price competition is not working as effectively as it could be.”
Additionally, worse performing funds were more likely to be closed or merged into better performing funds. And when this happened, although the performance of the weaker performing funds improved post merger, the performance of the stronger fund, on average, deteriorated slightly after the merger.
Based on its findings, the FCA has proposed an overall package of remedies “to make competition work better in this market, and protect those least able to actively engage with their asset manager.”
The remedies include:
- Clarifying expectations around value for money, increasing accountability through the Senior Managers and Certification Regime (SM&CR), and introducing a minimum level of independence in governance structures
- Requiring fund managers to return any risk-free box profits to the fund, and disclose box management practices to investors
- Making it easier for fund managers to switch investors to cheaper share classes, “which will drive competitive pressure on asset managers”
- Disclosure of a single all-in fee to investors, which will include the asset management charge and an estimate of transaction charges
- Recommending that the Department for Work and Pensions continue to review and remove barriers to pension plan consolidation
“We consider that this will increase efficiency, lead to the UK asset management industry being a more attractive place for investors,” said the report, “and so improve the relative competitiveness of the UK market.”