Following a near two-year investigation into competition issues in asset management the FCA told fund managers today to overhaul their charging structures, called for extra powers plus revealed future probes.
Here are the key things you need to know about what the regulator uncovered about the industry – and what steps the watchdog intends to take next.
1) Active managers aren’t worth lofty fees
The regulator reported firms do not typically compete on price, particularly for retail active asset management services.
Both actively managed and passively managed funds were found not to outperform their own benchmarks after fees.
However the regulator revealed many active funds offer similar exposure to passive funds, but charge significantly more for this.
The City watchdog estimated that there is around £109bn in ‘active’ funds that closely mirror the market which are significantly more expensive than passive funds.
The regulator found investors do not choose to invest in funds with higher charges in the expectation of achieving higher future returns.
However, the FCA’s additional analysis suggests that there is no clear relationship between charges and the gross performance of retail active funds in the UK.
There is some evidence of a negative relationship between net returns and charges.
According to the watchdog this suggests that when choosing between active funds investors paying higher prices for funds, on average, achieve worse performance.
The City watchdog found some evidence of persistent poor performance of funds.
However, the regulator also noted that worse performing funds were more likely to be closed or merged into better performing funds.
The FCA also found that the performance of the merging poorer performing funds improves after they have been merged.
However, the City watchdog also found that the performance of the recipient fund, on average, deteriorates slightly after the merger, although it is not clear that this is a direct result of the merger.
While mergers and closures may improve outcomes for some investors, the regulator found not all persistently poorer performing funds are merged or closed and it can also take a long time for worse performing funds to be pulled.
To address the issue regarding fees, the FCA is backing disclosure of a single all-in fee to investors and Mifid II will introduce this for investors using intermediaries.
This all-in-fee will include the asset management charge and an estimate of transaction charges.
Managers will also be required to be clear about why or why not a benchmark has been used. The FCA will require that fund managers use or otherwise of benchmarks is consistent across marketing materials.
2) Advisers to lose cash as relationships under spotlight
In a double blow to financial advisers, the paper questioned vertical integration and suggested pulling the plug on trail commission.
The City watchdog stated it wants to make it easier for fund managers to switch investors to cheaper share classes and therefore is seeking views on whether to introduce a phased-in sunset clause for trail commissions.
A sunset clause for on-platform trail commission came into force in 2016, but a significant volume of off-platform investment business continues to be bound by similar arrangements.
In such cases, investors remain in pre-Retail Distribution Review share classes paying commission to advisers, either because they no longer receive ongoing advice or because those legacy investments are still considered to be suitable.
The FCA also promised to address concerns about conflicts of interest in so-called vertically integrated firms.
These businesses - which own and control every part of the value chain from financial advice to selling products, platform administration and fund management - have emerged in the last few years, and are starting to dominate the market.
Major vertically integrated players include Standard Life and Old Mutual Wealth. Each has advice, platform, fund management and product selling arms, designed to capture all the needs of each customer, without the use of outside businesses.
Fears were flagged about model portfolios and outcome-focused products.
The main issues raised were they are poor value for money, including extra fees for limited additional value, have potentially higher tax liabilities if investors use a model portfolio, and have poor transparency.
The FCA stated in today’s paper that some of these issues will be covered in its upcoming market study into investment platforms.
3) Ratings agencies to come under FCA remit
The regulator has revealed fears about the relatively high and stable market shares for the three largest ratings providers, a weak demand side, relatively low switching levels and conflicts of interest.
The FCA has requested the power to regulate investment consultants after its asset management study raised concerns about conflicts of interest among these businesses.
The regulator raised a concern that gifts and hospitality from asset managers could create conflicts of interest for investment consultants that provide asset manager ratings and recommendation services to investors.
Questions were also asked about investment consultants providing these services to investors while at the same time providing consultancy services to asset management firms.
Specifically, the FCA flagged there were concerns that any revenues investment consultants earned from asset managers could create conflicts of interest.
Some investment consultants reiterated to the FCA that they have processes in place to ensure asset managers’ gifts, hospitality or revenue from providing services did not affect their advice while others argued the outings and presents they received were “insignificant and declining.”
However the regulator stated it was still concerned receiving rewards was resulting in certain fund houses receiving higher ratings.
4) Platforms under spotlight – again
The FCA will launch a market study into the platform industry next month, to probe if there are barriers to switching platforms.
According to the regulator it is not clear investors benefit from the economies of scale platforms provide and that it can be difficult to understand the full cost of an investment made through a platform.
Responses to the FCA’s consultation were generally supportive of the regulator carrying out more work in this area.
The FCA stated: “The responses confirmed our view that further work is warranted to ensure that investment platforms demonstrate and promote effective competition in the interests of consumers.
“To consider whether the issues apply across the market, we will be undertaking the investment platforms market study.”
The study will consider how direct-to-consumer and intermediated investment platforms compete to win new and retain existing customers and whether platforms allow retail investors to access investment products that offer value for money.
5) Time to pool pensions
The Department for Work and Pensions (DWP) was told continue to review and, where possible, remove barriers to pension scheme consolidation.
According to the FCA this should help those schemes who wish to benefit from economies of scale that might be achieved by such consolidation.
The FCA found smaller occupational pension schemes were less likely to be able to exert pressure on asset managers because they generally had fewer resources for governance and monitoring the performance of their asset managers and advisers.
Larger pension schemes were typically more attractive to asset managers, allowing trustees to negotiate lower fees per pound under administration.
Respondents to the FCA's consultation supported pooling in principle but highlighted significant barriers such as complex requirements about pensionable salaries and responsibilities of trustees and sponsors.
In December the DWP published a call for evidence on how processes for DC scheme bulk transfers without member consent might be simplified, to remove a key barrier to DC scheme consolidation, which the FCA recommended it continue with.
emma.hughes@ft.com
