The UK's Financial Conduct Authority has just released its 'terms of reference' for a massive asset management market study. Nobody knows where this will lead, but the regulators seem to be prepared to act on a sweeping scale and the interests of high-net-worth individuals are high on their agenda.

The FCA announced its intention to undertake a study of the asset management market in its business plan for 2015/16. This decision followed on from the regulator's findings during its "wholesale sector competition review." This identified some areas inside the asset management value chain where competition may not be working effectively.

Three prongs of enquiry

The FCA wants to find out whether competition is working effectively and enabling high-net-worth (and, indeed, both retail and institutional) investors to obtain value for money when buying asset management services. To do this, it says it wants to find out:

• how asset managers compete to 'deliver value,' whatever that means;
• whether asset managers are "willing and able to control costs and quality along the value chain"; and
• the effect of investment consultants and other advisors on competition for institutional investment management.

When it analyses each of these topics, the regulator will see whether there are any barriers to innovation or technological improvements that are preventing investors from getting the best for their money.

When it probes all the repercussions of the first question, the FCA will be asking how investors choose between asset managers, how the structure of the market affects competition between asset managers and how charges and costs differ along the value chain. In its attempts to answer the second question, it will be seeking comments and data about whether investors can monitor costs/quality of services paid for out of funds, whether service-providers who focus on winning business from asset managers benefit end-investors, and whether asset managers are able to control costs all along the value chain. The follow-on questions under the third line of inquiry need not trouble us, although the paper (MS15/2.1) admits that there is some crossover between the wholesale sector and retail investors because many HNW assets are tied up in corporate vehicles over which they have control. Pensions are also relevant here. Point 3.7 says: "The distinction between retail and institutional investors is not straightforward. Even though they are labelled as institutional, the end-beneficiaries of many institutional investments are often retail investors and the shift from defined benefit pension schemes to defined contribution schemes has contributed to this."

The regulator estimates that £6.6 trillion of assets are managed in the UK. Of this, around 80% are managed on behalf of institutional investors (including pension funds) and around 20% on behalf of retail investors (including HNWIs). Retail investors are increasingly using platforms to access services.

Some points in more detail

Asset management products offered to investors can be complex, which may prevent investors from selecting the 'best value' product for them. The FCA would like to weed out those products that are unnecessarily complex and do not serve the end-investors well.

Investors, especially retail customers, appear to base their decisions based on past performance, reputation, marketing, advertisements and other things. The FCA believes that this could be because they find it difficult to assess other features of products or services. It wants to find out "whether they are good indicators of value for money (i.e. net returns for a given risk tolerance and/or service quality)."

Retail (including HNW) consumers are not good at assessing risk and uncertainty. Indeed (as wealth managers know) by and large they find financial products complex, and the process of financial decision-making hard, unpleasant and time-consuming. The regulator will be looking into this and other 'behavioural biases,' as it calls them.

The paper criticises some fund firms for not presenting investing fees and fund charges as helpfully as they might, for instance by using the annual management charge (instead of the 'ongoing charges figure,' a European Union statutory term for a charge which includes the AMC and other operating costs such as fees that go to trustees, depositaries, auditors and the regulator itself) as a so-called 'headline figure' on marketing material and other disclosures, and/or providing unclear descriptions of administration charges which make it more difficult for investors to directly compare funds with each other. The regulator, then, plans to look closely at the way funds and platforms display information and is not necessarily in favour of an increase in the data to be presented, as the sheer volume of it might bewilder customers.

How easy is it for different investors to act in response to the information they gather and assess? The FCA wants to look at the trials and tribulations of switching between funds, especially when there are 'lock in' charges. It will also look at the time and effort that HNWs spend in finding an alternative fund and the real or imaginary ‘tax complexity’ involved in switching.

Here and there

Also on the menu are enquiries about the difference that the Retail Distribution Review (RDR) has made to the total charges that platforms levy on retail investors (after platforms were required to charge explicitly for their services and were banned from earning commissions from asset managers). There will be an analysis of the profitability of the asset management sector. Pooled investment funds, insurance-based investment products and segregated mandates are firmly in the firing-line.

The study will not look at the provision of investment advice by independent financial advisors (IFAs) to investors. It will look at wealth management firms but only insofar as they provide and distribute asset management products and services. Whenever a stockbroking firm provides services similar to those of an investment platform (selling and distributing asset management products) it, too, will be scrutinised, but not otherwise. The market study will not focus on private equity funds and venture capital funds.

Behaviourism is never having to say you're sorry

Lying behind all this is a paper the regulator produced 2½ years ago (occasional paper no 1) that outlined the emotional decision-making processes of the investing public. It looked at how consumers make predictable mistakes when choosing and using financial products, how firms respond to these mistakes, and how behavioural biases can lead firms to compete in ways that are not in the interests of consumers.

Faced with complexity among products, consumers can simplify decisions in ways that lead to errors. Many products involve trade-offs between the present and the future. Decisions may require an assessment of risks and uncertainties, something at which most people are terrible, decisions can be swayed by stress, anxiety, fear of losses and regret, rather than the costs and benefits of the choices, some products permit little learning from past mistakes, and some financial decisions are made infrequently, with little learning from others, and with consequences revealed only after a long delay.

Ten bad habits and ten remedies

There are ten behavioural biases and effects in retail financial markets, according to the paper.

• First, bad preferences. One is 'present bias,' e.g. spending on a credit card for immediate gratification. The regulator's remedies for this, it says, might be to embark on information campaigns and to require firms to ask every consumer to make an active choice to opt-in or opt-out after the trial period expires.

• 'Reference dependence' and loss aversion are another stumbling block, for instance the belief that insurance added on to a base product is cheap because the base price is much higher. Here the FCA thinks it might provide alternative 'anchor' or reference points that can lead consumers to make better choices (e.g. it might increase minimum repayment values for credit-card balances or introduce another reference value, as the current low values reduce the amounts that consumers repay, or it might suggest shorter time-frames for repayment). It might also restrict the use of irrelevant product alternatives (e.g. insurance ‘optional extras’) and refer to losses in letters about redress to consumers to encourage responses.

• Regret and other emotions, e.g. buying insurance for peace of mind, are also bad. Here the FCA is thinking of encouraging consumers to think hard about whether they will really experience strong regret in the future and introduce ‘cooling-off’ periods.

• Rules of thumb can lead to incorrect beliefs and these are another problem. Firstly, there is overconfidence, as with excessive belief in one’s ability to pick winning stocks. The FCA's remedies here are limited to warning customers about this and to require them to think the problems through, perhaps by forcing them to fill in forms about the validity of their ideas.

• Over-extrapolation, e.g. extrapolating from just a few years of investment returns to the future, is another problem. Remedies include the design of 'smart' information disclosures (timely, relevant, simple and easy to understand) with heavily regulated predictions of the future of the investments. The FCA also might regulate the way firms provide consumers with information (perhaps on the past return of investment products) and what information to give them.

• Projection bias, which might happen when one takes out a loan without considering payment difficulties that may arise in the future, is another example. Again, the FCA boffins think that it might be an idea here to set ‘cooling-off’ periods for product purchases.

• Finally, we use decision-making short-cuts when assessing available information. First among these is framing, salience and limited attention, which happens when one overestimates the value of a packaged bank account because it is presented well. The remedy, according to the regulator, might be to standardise 'frames' (a piece of sociological jargon that it never defines) that firms use to set out product fees and charges to “ensure comparability across products.”

• Mental accounting and narrow framing is bad and the HNWI might make investment decisions asset-by-asset rather than considering the whole investment portfolio. So-called 'smart' information and the regulation of information sent to consumers (e.g. telling firms to calculate returns on investment products over prescribed time periods only) are remedies here as well.

• Decision-making rules of thumb are bad here too because, for example, investment may be split equally across all the funds in a pension scheme, rather than as the result of a careful decision about allocation. A regulator can in this case either suggest alternative decision-making shortcuts of its own choosing or change the decisions that consumers face by presenting them with the most salient information or something similar.

• Persuasion and social influence is another factor here, as with when one follows financial advice because an advisor is likeable. On this subject the FCA is refreshingly candid: “very little can be done.”

A disclaimer

The regulator covers itself with a disclaimer against any charge that it is always suspecting rapacious funds and platforms of winkling money out of bewildered customers: "We must be mindful, however, that sometimes firms might not know that their customers are making mistakes. What looks like deliberate exploitation may actually just be firms responding to observed consumer demand without realising that it is driven by biases."

The fuzzy word 'detriment', which was very fashionable among regulators two years ago, appears 26 times in the 71-page paper and is the great underlying fear here. Only time will tell whether the FCA employs its remedies of 2013 to fight what it calls "detriment to customers" at the end of this information-gathering exercise.