The definition of "value" in fund management has always been elusive: is it returns? Cost? Service? Risk?
From the start of next year, the regulator is demanding that fund managers start to define the value they provide to their investors. Is this simply another box-ticking exercise or could it be a useful tool in the hands of investors?
The concept of a value assessment emerged from the FCA Asset Management Market study in 2018. It suggested that individual open-ended funds must have at least two independent directors, making up at least 25% of the board. Initially, the regulator said that fund managers must provide an annual assessment to the board on whether the charges taken from the fund were justified in the context of the overall value provided.
In the course of discussion with the industry, the goalposts have moved a little. The FCA’s focus on cost has been toned down - today the focus is on "value" rather than "value for money". At the same time, a raft of other considerations has been introduced. Today, the FCA’s "non-exhaustive list of elements prescribed for the assessment" includes: quality of service, performance, fund management costs, economies of scale, comparable market rates and classes of units.
This list is loosely based on the so-called Gartenberg principles, a set of rules derived from U.S. case law designed to identify "excessive fees". It stems from a 1982 case, which saw an investor, Gartenberg, sue Merrill Lynch in the U.S. for purportedly high fees and poor value for money on its money market fund. After initial defeat, the case was upheld and has formed the basis for value assessments in the U.S. and elsewhere.
However, the FCA has chosen not to issue the industry with a template for these new value assessments. This is deliberate, says Steve Kenny, commercial director at Square Mile Research, as it attempts to force the industry to raise the bar on reporting: “The regulator is trying to encourage competition on how the industry displays the information. This should bring about better standards overall.”
The rules compel fund groups to introduce the value assessments four months after their accounting year end. Those with an accounting year ending 30 September will be the first to issue the assessments. They will be aware they are under scrutiny and, as such, are likely to think hard about what they deliver.
Mike Webb, chief executive officer at Rathbones Unit Trust Management, says the FCA is trying to move to a new definition of success: “The regulator is asking that when we sell a fund to a client, we create an expectation in their mind. We then report against that expectation.” Rather than every fund having to report, for example, one, three and five year performance numbers and certain risk scores, the fund management groups can do more to shape the metrics against which they will be measured.
This sounds straightforward in theory, Webb says, but is complex in practice: “There are issues around the time horizon you use. There is also the issue that in stressed markets, investors might need to commit capital for longer.” While the intention is good – to match outcomes with expectations – it cannot be a formulaic approach.
He adds: “Our approach is to define the nature of each fund and write it down in plain English. We are saying ‘this is the ride that you will experience in normal markets and you can judge us against that’.” This is far more than simply cost versus performance, but will take into account issues such as the viability of the business, risk controls and execution of strategy.
The quality of the independent directors who are appointed to oversee these value assessments will be important, as will the supervision of the FCA. The system will only be as good as the oversight that is put in place. However, there is evidence that it works, notably in the investment trust sector, where boards have shown themselves willing to hold managers to account and act in the interests of shareholders.
Kenny says: “This could be an important cultural shift. The asset management industry is being asked to make sure it delivers from the perspective of the recipient, removing any lack of clarity, promoting better governance and outcomes. Delivering better outcomes should improve the reputation of the industry.”
He believes there may also be better transparency around the costs that fund managers are absorbing – from stamp duty, to broker fees, to custody charges. There may be some consolidation in the number of funds in the market place with underperforming vehicles merging into others. While the new rules could cause some pain in the short-term, it should create a stronger industry in the long-term.
