The value assessment conundrum for the funds industry
February 13, 2020 • 8 min read
Since the end of January, fund houses across the asset management industry have been obliged to publish assessment of value (AOV) statements on their websites.
This requirement has been in the making for a few years (as part of the FCA’s 2018 Asset Management Market Study) and drives the point that asset management firms need to demonstrate they are delivering value for investors.
While the asset management industry has had some time to put together its solution to the (AOV) requirement, last year the issue of value-for-money very loudly became centre of attention. First with the Woodford scandal, when thousands of investors became trapped in the flagship fund managed by former ‘star’ fund manager Neil Woodford. Despite being stuck in a gated fund, that had been become quartile for some time beforehand, investors were still charged considerable active management fees.
And then, Janus Henderson was fined £1.9m by the FCA for overcharging retail investors in two funds it was effectively running as closet trackers (the first time a fund group has been fined for such a thing).
The fine followed £1.8m of compensation paid to the more than 4,700 retail investors holding the open-ended funds, who weren't told about the effective switch to a passive investment approach, or offered a lower fee, for nearly five years.
The fund group's attitude towards its retail clients contrasted with its treatment of the funds' larger institutional investors, who were not only told about the change but had their fees waived.
FCA executive director of enforcement and market oversight Mark Steward said: “The FCA requires firms to treat all its customers fairly, not just some customers.”
For the FCA, these scandals emphasised the need for AOV statements to be published on firms’ websites and - as we’ve written on in-depth - there is a perfect storm gathering over financial promotion regulations with the high profile LCF scandal acting as a prominent catalyst.
Financial promotion rules were introduced to protect consumers from buying financial products and services that are not right for them (i.e. highly risky mini bonds, loans with overly aggressive rates of APR etc). This is all wrapped up in the FCA’s ongoing mission to strengthen suitability within financial advice, ensuring consumers are sold products and advised in a way that is suitable for them (on an ongoing way).
And, to banish any doubt about its stance, the FCA issued a ‘Dear CEO’ letter to the asset management industry in January this year. Even though, by its very name, a ‘Dear CEO’ letter doesn’t address any specific individuals or firms the regulator couldn’t be less subtle in its language: “Overall standards of governance, particularly at the level of the regulated entity, generally fall below our expectations.
"Funds offered to retail investors in the UK do not consistently deliver good value, frequently due to failure to identify and manage conflicts of interest. Inadequate investment in technology and operational resilience has led to deficient systems which could cause harm to market integrity or loss of sensitive data.”
Even though specific firms weren't named, the FCA was brutal in its language and - for an industry responsible for trillions of invested pounds - this makes for a startling admission.
In the same latter the FCA went on to say:
“We will do work in the first half of 2020 to understand how effectively firms have undertaken value assessments. We will seek evidence of meaningful challenge at AFM boards on proposals made by the executive – including on costs, fees and product design. We expect you to ensure that funds’ objectives are clear, fair, not misleading and that they comply with the new rules around objectives disclosure as we assess and authorise investment funds.”
According to the FCA, AOV statements must be centred around seven criteria. These are:
Quality of service: the range and quality of services provided to investors.
Fund performance: the performance of the fund, after deduction of all payments out of scheme property as set out in the prospectus. Performance should be considered over an appropriate timescale having regard to the scheme’s investment objectives, policy and strategy.
AFM costs: in relation to each charge, the cost of providing the service to which the charge relates, and when money is paid directly to associates or external parties, the cost is the amount paid to that person.
Economies of scale: whether the authorised fund manager (AFM) is able to achieve savings and benefits from economies of scale, relating to the direct and indirect costs of managing the scheme property and taking into account the value of the scheme property and whether it has grown or contracted in size as a result of the sale and redemption of units.
Comparable market rates: in relation to each service, the market rate for any comparable service provided by the AFM, or to the AFM or on its behalf, including by a person to which any aspect of the scheme’s management has been delegated.
Comparable services: in relation to each separate charge, the AFM’s charges and those of its associates for comparable services provided to clients, including for institutional mandates of a comparable size and having similar investment objectives and policies.
Classes of units: whether it is appropriate for unitholders to hold units in classes subject to higher charges than those applying to other classes of the same scheme with substantially similar rights.
The first few AOV statements are starting to be published but problems have already begun to arise. Hargreaves Lansdown was one of the first out of the gate, and has raised eyebrows by evaluating its multi-manager range as 'value' despite noticeable exposure to the notorious Woodford funds in the past and underperformance across eight out of 10 funds.
Creating and publishing AOV statements poses a significant challenge for fund houses of all sizes. Defining ‘value’ is no easy task and will vary significantly across asset classes, investment structures and categories of investors. Initially, fund houses may want to look at performance but something as simple as comparing a fund’s performance against a benchmark may not be enough.
And when it comes to assessing the cost of the service provided, this could be a complex challenge as well (regulations already demand transparency around cost disclosure, to what extent should a AOV statement go into cost breakdown?). As part of the process, comparisons have to be made with both external and internal costs and the assessment process will require consideration of factual, quantitative and qualitative information, from both internal and external data sources. And, unfortunately, the IA is unable to provide standards or templates for these statements due to competition laws.
Putting these AOV statements together is the responsibility of the regulated firm and, as we can see, there are many considerations and challenges to overcome (however, KID requirements under PRIIPS could be a helpful guide). However, there is support available for regulated firms.
Creating these AOV statements isn’t the entire requirement for compliance, firms need to be able to evidence that they have these AOV statements published on their websites – full of all the required information for the benefit (and protection) of investors. The Janus Henderson case highlights how far back regulatory investigations can go back – while the fine was issued in 2019, the actual mischarging happened several years earlier.
As we know, compliance is an ongoing requirement and firms need to be able to show at points in history that they were meeting various regulations. If a compliant or issue is raised, firms need to be able to go back in history and evidence their activities and compliance actions at a set point in time.
This is why website archiving is proving so popular with firms. Having screenshots of what was published at a certain time on a website fails to offer a fully compliant solution and with firms being held increasingly responsible for their digital presences (with websites essentially being financial promotions, live 24/7) a more in-depth solution is needed. Website archives are living, breathing snapshots of a website at a certain point in time and an ISO-compliant, time-stamped and tamperproof archive can be invaluable in dispute resolution and satisfying queries from the regulator.
Being able to demonstrate you comply with regulations is now almost as important as meeting them in the first place. With the onus on evidence now critical, many firms use solutions such as the MirrorWeb Platform which creates reliable and 100% accurate web records of their web channels so they can evidence what was published and when, with full accuracy.