Active fund managers will have winced recently at the FCA’s damning report about the value they offer, but the pain could get much worse if they don’t shape up.
The FCA recently published one of the most critical studies of the asset management sector I’ve seen in many years – the FCA's interim report to its Asset Management Market Study - effectively questioning the value of active fund management and asking whether the fees charged were justified.
The regulator accused the sector of “weak competition” between managers and warned reform may be necessary.
Ratings agency Moody’s, a serious voice in this business, has already warned that if reform is forced through by the FCA the active fund management sector faces a squeeze on profit margins and consolidation as smaller, and perhaps weaker managers, struggle to justify themselves.
This is an issue of huge importance to the financial adviser sector and to the retail asset management world. It goes to the core of what many advisers do – manage investments.
One of the most intriguing FCA proposals was for an all-in-one fund fee to be disclosed to investors to enable them to compare charges easily between funds. I’ve been irritated for many years by the growing plethora of charges added to funds which make comparison difficult. I attended the Morningstar Investment Conference earlier this year where there were some impassioned pleas for an all-in-one fund charge, so pressure for this is growing.
The question now is where next for the active fund management sector?
I don’t believe it’s the end – far from it. Good and experienced managers will always be able to produce outperformance that investors will be willing to pay for and why not?
There is risk with any investment and it’s up to the investor and their adviser to choose the level of risk they are comfortable with.
If investors want to take more risk in an active fund for potentially higher returns then I can’t see the issue with this, so the FCA will need to be careful not to harm the UK’s great reputation as an active fund management centre with centuries of experience.
However, reform is necessary. There are simply too many active funds that fail to perform. One firm even refers to them as 'dog' funds and other advisers name and shame them on a regular basis.
Too many fund managers, and here the former life companies are often at fault, leave investors in high charging, dismally performing active funds which are little more than cash cows for the providers. Any reform that brings this to a halt would be welcome.
The issue of active versus passive fund management always comes up at this stage. One view I’ve heard many times is that holistic financial planners are only interested in low-charging passive funds these days and shun active funds.
Research shows this is not true, and even the best qualified financial planners will consider and use relatively high-charging active funds for the right client in the right circumstances.
Even the best qualified financial planners will consider and use relatively high-charging active funds for the right client in the right circumstances.As part of an efficient portfolio, there is no reason why an investor would not invest at least a part of their portfolio in actively managed funds, seeking long-term outperformance.
Despite this, though, it’s fair to say that most fund managers have been ramping up their passive fund offerings recently, perhaps seeing the writing on the wall.
I’m old enough to remember when index-tracking funds were first introduced to the UK, and how many were sceptical that they would take off. Well take off they did and now they are a mainstay for many investors, and that won’t change, but they won’t be the whole picture.
So what can active fund managers do to keep up and what role do advisers have? These are more difficult questions, and it remains to be seen what reforms the FCA will attempt to push through. However, the issue is on the radar, and it would be a brave active manager who chose to ignore the warning signs.
The Investment Association has a key role to play here in building a consensus for change and several of the major fund managers have already said they will “engage” with the regulator.
The Investment Association needs to lead this process and seek common ground among providers. It has sometimes seemed to struggle to find consensus, but fund managers must accept the need for change.
Running funds that underperform year after year and simply deplete investors’ funds by charging too much is simply not acceptable any more, and that has to end. The days of high charges in return for dismal performance are over.
Kevin O’Donnell is a financial writer and journalist
