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UK watchdog slams fund managers’ high profits and lack of price competition

  • UK financial watchdog calls out fund managers' 36% average profit margins and lack of transparent disclosure
  • Investment consultants and intermediaries come under particular fire
  • £109 billion identified in active funds which simply 'mirror' benchmarks

The U.K. financial watchdog has blasted the domestic fund management industry for anti-competitive price practices and a lack of transparency over costs and performance as part of a long-awaited report released on Tuesday.

According to the Financial Conduct Authority's (FCA) damning report which follows an investigation launched in November 2015, fund managers enjoy an average profit margin of around 36 percent while the majority of both actively and passively managed funds fail to outperform their benchmarks once fees are taken into account.

The FCA was keen to emphasize that it was not suggesting that active funds were inferior to passive funds but that it was critical for the industry to improve transparency in order that investors could make informed decisions about the total costs extracted by funds and their actual ex-post performance, net of fees.

The warning was sounded over the performance of high fee funds in particular, with the report noting that "there is some evidence of a negative relationship between net returns and charges. This suggests that when choosing between active funds, investors paying higher prices for funds, on average, achieve worse performance."

Coming under particular attack were the funds which purport to be active but in fact contain holdings that differ only minimally from their benchmarks.

"We find that many active funds offer similar exposure to passive funds, but some charge significantly more for this. We estimate that there is around £109 billion ($139 billion) in 'active' funds that closely mirror the market which are significantly more expensive than passive funds," observed the report's authors.

Also under fire were investment consultants which act as middle men between investors and asset managers, providing fund selection and analysis services to end clients.

The report highlighted concerns relating to conflicts of interest and oligopolistic market tendencies for investment consultants and said it recommended bringing the industry under the regulatory remit of the Treasury.

Turning to retail intermediaries, the FCA said that it has concerns about the value they provide to customers.

What the industry thinks

The fund management industry had been pre-warned of some of the likely conclusions given the interim report released last November read along very similar lines.

Many industry participants put on a brave face despite the inevitable costs set to come with regards to incorporating these proposals into their business practices and said that they looked forward to working with the FCA as it turned the recommendations into practical rules.

"The FCA's proposed remedies around fund manager governance, price disclosure and on benchmarking and objectives all appear to strike a sensible balance between disruption and stability, and are clearly taking account of investors' long term best interests: they're challenging the industry without dismantling it," said Tom McPhail, head of policy at Hargreaves Lansdown, in an email to clients on Wednesday.

Indeed, the tone of the final report is friendly rather than confrontational given its lack of concrete demands at this stage, according to Keith Baird, director of financial services research at Cantor Fitzgerald Europe.

"The fact the FCA says it 'supports' action on moving to an all-in fee, rather than using firmer language, is supportive for asset managers. However, there could be a potential sting in the tail next year when the final rules come in via European legislation," he evaluated in an email to clients on Wednesday.

"The most prescriptive part is around profiting from box profits, and that will now have to change," he added, referring to the practice of fund managers creaming off a risk-free spread between different prices charged to customers who are entering or exiting a fund.

The UK FCA will co-operate with Hong Kong’s SFC in enabling fintech firms to more easily access the respective financial services marketplaces.
Chris Ratcliffe | Bloomberg | Getty Images
The UK FCA will co-operate with Hong Kong’s SFC in enabling fintech firms to more easily access the respective financial services marketplaces.

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