The UK's Financial Conduct Authority has penalised a large fund management firm for not reducing the fees that it was extracting from 4,713 direct retail investors when it began to manage the funds in a less active way, while giving the institutional investors in those funds preferential treatment.

The funds in question were Henderson's Japanese and North American funds. The firm significantly reduced the level of active management of these funds in November 2011 and at length informed nearly all of the institutional investors who were affected by this change and offered to manage these two funds for those investors without charge, only leaving out two institutional investors and 75 intermediary companies with underlying non-retail investors.

Henderson also solicited the views of institutional investors in its governance of the funds. Towards the end of 2015, a subcommittee of its executive committee called the Global Strategic Product Committee considered a plan to 're-enhance' the two funds but abandoned the idea when an institutional investor in those funds complained. An enhanced index fund, according to Investopedia, is a fund that seeks to enhance the returns of an index by using active management to modify the weights of holdings for additional return.

The FCA's decision notice for Henderson says of the firm: "Its internal discussions almost entirely focused on the impact that [a] change in investment strategy would have on its institutional investors. It identified that the change would affect some of its institutional investors who had been promised specific outperformance targets, as the change would mean that those targets could no longer be met."

Henderson began to contact institutional investors in the two funds in November 2011, stating clearly that the funds would become passively managed: “Within global Enhanced Index mandates, where most clients have a UK biased benchmark, the North American and Asian regions will move to being managed on a passive basis, subject to regulatory and client approvals being obtained, with the UK and Europe-ex UK regions continuing to be run on an Enhanced Index basis...We propose to manage the passive portion of the portfolio for free – not at passive fees, for free.”

The importance of being even-handed

It was a very different story for the two funds' retail investors, who between them owned only £37.8 million or 5% of their AuM. Henderson decided not to tell the retail investors invested in the Japan and North American Funds about the change in the investment strategy and did not reduce the fees they paid by from their existing management fees. These fees ranged from 75 to 150 basis points, depending on the share class in which they were investing.

Nobody oversaw Henderson's decisions about amendments to prospecti, communications with investors or fees. These decisions, moreover, were were not logged in any formal documents. Henderson did not consult its compliance team before making these decisions, nor did it subject them to any scrutiny by an internal governance committee at the time. Henderson charged investors £1,784,465.32 more than if they had invested in a passive fund. It has now told all affected customers and compensated them for the extra costs they incurred.

It took Henderson's top brass about four-and-a-half years to realise that it was putting retail investors at a disadvantage. At the monthly Investment Performance and Risk Committee’s meeting on 10 November 2014, staff finally explained that the two funds were “close to passive” and that, although “the team would like to be in a position where all funds are enhanced...a deadline has not been set for this yet.” The committee, a subsection of the firm's executive committee, became aware at this meeting that there were retail investors in these two funds and that “communication to the retail investors hasn’t been as effective,” a euphemistic phrase that belied the fact that the retail investors remained totally oblivious. The IPRC agreed to a six-month period during which either the Japan and North American Funds were to become enhanced again or the names of the funds were to be changed to remove the word “enhanced”. All in all, it looked at the problem for nine months but took no decisive action.

The FCA holds that Henderson contravened "Principles for Business" 3 (management and control, between November 2011 and August 2016) and 6 (customers’ interests, between November 2011 and March 2017).

Henderson's rationale for continuing to call the funds 'enhanced' became increasingly unsustainable over time and, the regulator believes, should have been subject to greater scrutiny from the risk and governance committees that Henderson relied on to oversee the management of the funds.

Principle 3

The firm's transgressions against principle 3 are especially worthy of note. The FCA is vexed about the fact that nobody was really clear about the accountability and responsibilities of Henderson Investment Funds Ltd (as the appointed authorised corporate director) and  Henderson Global Investors Ltd (as the appointed investment manager) regarding the making of decisions about products. The delegation and escalation processes between the two entities were not clear, especially when it came to things that one had delegated to the other and decisions that should be referred back to the delegator.

The FCA also dislikes the absence of an internal rule that called for such problems to be 'escalated' to, or considered by, any governing committee before Henderson Global Investors made these decisions; and the absence of a written-down process that required Henderson Global Investors to consult a compliance officer before making these decisions.