Another panoply of new rules and/or penalties seems to be looming on the distant horizon as the UK's Financial Conduct Authority publishes its first report on competition in the asset management sector. One of its aims is to impose clearer price disclosure.

The regulator has been making enquiries about the operating margins of asset management firms, the charges that asset managers take out of funds and mandates, and the econometrics behind net flows of funds between asset managers. It has also commissioned research into the ways in which retail (and institutional) investors make decisions and choices. Its desire to look into the subject might have something to do with the fact that one of the unelected organs of the European Union - of which the FCA is a staunch admirer - is thinking of asking regulators in its territory to investigate asset management performance and fees.

The UK’s asset management industry consists of 1,840 regulated firms and is the second largest in the world, managing £6.9 trillion of assets. It manages more than £1 trillion on behalf of British retail investors and £3 trillion on behalf of British pension funds and other institutional investors. The industry also manages around £2.7 trillion on behalf of overseas clients. The investor, as is well known, bears virtually all the risk. Since 2005, passive funds in the UK have grown by nearly fivefold and now account for 23% of the assets under management.

The FCA began to study the sector in November by asking the following questions.
• How do investors choose between asset managers?
• How do intermediaries and fund governance bodies affect competition between asset managers?
• What do prices, profits and performance tell us about how competition is working?
• Are asset managers willing and able to control costs and quality all along the value chain?
• How do investment consultants affect competition for institutional asset management?
• Are there barriers to innovation and technological advances?

The study covers mainstream and other asset managers, pooled vehicles, segregated mandates, retail/HNW consumers, pension funds, and insurance companies. Among so-called 'third party' products and services it also 'partially' covers investment and portfolio management systems, stocklending services, and benchmarking data. Among administrative or ancillary services it also 'partially' covers custody, fund administration, risk management, and other things. It also looked at hedge funds, discretionary private client managers, custodial banks, and platforms. It demanded information from 37 asset managers selected to give the FCA a range of sizes, businesses models, strategies and types of customer, 13 investment consultants and 8 platforms and talked to 20 asset management firms, 13 providers of ancillary services, 8 investment consultants, 8 advisors and networks and three trade bodies.

In looking at how investors choose between asset managers, the FCA found the following.
• Investors typically consider value for money to be risk‑adjusted net returns.
• Investors are not always readily presented with a choice of passive funds through platforms and rating providers.
• When choosing products and providers, past performance, reputation and charges matter, with retail investors less sensitive to prices than institutional ones.
• Past performance information is difficult to interpret and compare and does not appear to help people when they are trying to predict future outperformance.
• 'Best buy' lists that platforms offer and recommendations from investment consultants do not, on the whole, help investors to identify products that, after charges, outperformed the benchmark. The FCA found that no firm listed any passive funds on any 'best buy' list before January 2014 and that platforms and other firms do not present passive funds in a favourable enough light.
• Retail investors ought to take information about charges into account when choosing and monitoring investment products because charges are a drag on performance and reduce the net returns that they are going to receive. Charges can be difficult for investors to understand, especially when they are expressed in percentage terms.
• Switching is fairly infrequent. There are no major barriers to switching but investors find it hard to judge whether and when it is best to switch.

When looking at pricing, the FCA found considerable price clustering for active equity funds, with many funds priced at 1% and 0.75%, particularly once assets under management are greater than around £100 million. This, it claims, is consistent with firms’ reluctance to undercut each other by offering lower charges. The regulator has noticed that as the size of a fund increases its price does not fall, suggesting it is the fund manager instead of the investor who benefits from the resultant economies of scale.

To address its concerns, the FCA is proposing the following remedies.
• Asset managers are already obliged to act in the best interests of investors but the FCA wants to make their duty to do so more onerous, holding them accountable for "how they deliver value for money."
• It wants to introduce an all-in fee approach to quoting charges so that investors in funds can see what is being taken from those funds easily.
• It wants to help HNW investors identify the best fund for them by:
(a) requiring asset managers to be clear about the objectives of this-or-that fund and report 'against' these objectives continually;
(b) making the appropriate use of benchmarks "clearer" and "stronger";
(c) providing tools to help investors identify persistent underperformance.
• It wants to make it easier for retail investors to move into better value share classes.
• It wants to see firms telling HNW investors about fund charges and their importance (at the point of sale and subsequently) more clearly than they do today.
• It wants a greater and clearer disclosure of fiduciary management fees and performance.

It adds: "We have also found that retail investors face difficulties understanding the full cost of investment, including distributor fees, and have some concerns about whether intermediaries deliver value for money. So we are proposing further FCA work on distribution in the retail market."

Reactions from practitioners

Mark Pugh, the "UK asset management leader" at the accountancy firm of PricewaterhouseCoopers, said: “The findings present a significant challenge to the asset management sector. We've been expecting the regulator to make substantial use of its wide ranging competition powers, and today's interim findings suggest that the asset management sector will feel their full force.”

Pugh said that asset managers had already been "focusing on transparency and cost" but added that the FCA's paper suggested that they “clearly need to do more.”

He noted that although the industry should welcome regulatory remedies, “the diversity of the asset management sector is critical to the success and growth of the UK and the FCA must balance this in its approach”.

“Some of the FCA's remedies may reduce 'costs' to consumers, but we must be careful not to focus purely on 'cost' to the detriment of 'value.'”

Jason Hollands, a managing director at Tilney Bestinvest, one of the country's largest asset managers, was also worried about the damage that the FCA's study could cause to the industry.

“I would expect the study published by the FCA to weigh negatively on the share prices of UK-listed managers today, especially those with sizeable retail client books,” he said.

Echoing Pugh's thoughts, Hollands opined: “Some might question whether a primary emphasis on cost is an appropriate measure of competition for products that are designed to deliver performance.”

Hollands said that "greater clarity around costs and performance" would clearly be helpful to investors, but not without implications for the industry, adding: “The implications of all this for management groups are higher regulatory and compliance costs on the one hand and further pressure on fee margins on the other, at a time when traditional active managers are facing much greater competition from the passive industry through the rapid growth of the exchange-traded fund market.”