FCA clamps down on closet tracker funds
The FCA has said asset managers must clearly state how funds are managed relative to benchmarks after a review of the industry uncovered a lack of disclosure regarding potential “closet trackers”.
A thematic review by the watchdog, encompassing 23 sample funds from 19 firms, found seven key investor information documents (Kiid) lacked clear descriptions of how funds were managed, five of which “used a benchmark-related approach that should have been disclosed”.
In response, the FCA has demanded fund groups do more to clarify how products are managed in relation to their underlying indices.
“Funds with benchmark-related strategies must disclose the benchmark and, for active funds, the degree of freedom the fund manager has relative to the benchmark,” it said.
“Fund management firms should check whether their documents are clear and, if the fund has a strategy related to a benchmark or has invested a material part of its portfolio to track an index, that this is adequately disclosed.”
The regulator’s study found that three funds were using “enhanced index strategies without adequately disclosing this”.
It pointed to the hypothetical example of a fund having a limited outperformance target and a limited tracking error as a product which would fall into this category.
A further two products reviewed “did not mention in the funds’ prospectus, Kiid or factsheet documents that as part of the funds’ overall strategy, approximately 20 per cent of each fund’s assets were passively invested to track an index”.
The regulator said it would require firms at fault to make specific improvements to practices, and added: “All fund management firms should consider the findings in this paper and review their arrangements accordingly.”
Despite these and other criticisms, the FCA said its review found “that fund management firms are taking the right steps to meet investors’ expectations.”
Its comments come after the European Securities and Markets Agency (Esma) found up to 15 per cent of Ucits equity funds may be closet trackers, with the organisation committing to further regulatory work as a result.
A spokesman for the watchdog said today that its ongoing work had “fed into” the Esma findings, published in February.
Megan Butler, FCA director of supervision - investment, wholesale and specialists, said: “The industry needs to consider how it communicates when funds are linked to financial benchmarks.”
“It is also vital that funds keep investment practices under review so they match their stated aims and strategy”.
Other failings
The FCA’s thematic review, entitled ‘Meeting Investors’ Expectations’, also highlighted problems relating to distribution and funds which were no longer actively marketed to investors.
The regulator said it had found two funds, intended to be advised products, which were nonetheless available on execution-only platforms - unbeknownst to the fund manager.
It also found “a concentration of issues” suggesting firms were not adequately monitoring funds which were no longer being marketed.
Outlining one particular example of poor practice, it said: “One firm decided to review the annual management charge (AMC) of two funds following negative publicity.
“The AMC was reduced, in part because a charge for advice that was included in the fee was no longer necessary. The firm consciously restricted the scope of its internal review and did not review other funds with similar advice charges built into the AMC.
“This included the fund in our sample which was not actively marketed.”
The FCA also reviewed “distribution oversight” at ten firms, finding two were failing to monitor sales in order to identify unexpected patterns among distributors.
However, it noted five firms were investing in ways to better understand end-customers, and praised one firm’s use of specific indicators - such as cancelled sales and high customer churn - as potential warning signs.
Responding to the review, a spokesperson for the Investment Association (IA) said: “The [IA] believes that being clear with clients about fund aims and objectives is crucial to ensure people are able to enjoy the full benefits that investing can offer.
“We are pleased that the FCA has recognised that most funds have high standards to ensure investment practices match stated aims. The industry will continue to work closely with regulators and distributors to ensure that disclosure standards and investor expectations are met across the retail market.”
