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Investment platforms and fund managers roughed up in FCA final report

Image of the City of London, where the FCA report says change is needed

The Financial Conduct Authority (FCA) is to launch an investigation into investment platforms such as Hargreaves Lansdown, amid concerns that market competition may not be delivering value to consumers.

The FCA says its forthcoming Investment Platforms Market Study will:

…consider how investment platforms and firms offering similar services in adjacent markets compete to win new customers and retain existing customers.

True, that doesn’t sound wildly excitement. It’s certainly no Liam Neesom Taken speech.

But reading between the lines, it seems the FCA has concerns that the largest platforms are not passing on their economies of scale to consumers, that they do not justify their dominance by securing big discounts on fund charges, and that they may not be doing enough to bring passive funds to consumers’ attention.

Where are the customers’ yachts?

The FCA announcement (and the lines you can read between) have come via the its final Asset Management Market Study.

The report – available to download as a PDF – also has plenty to say on fund managers and fees.

On fund charges, the FCA believes there’s not enough signs of competition in the market. It sees evidence of price clustering, and notes that while the growth in passive investing has coincided with falling prices for index funds over the past ten years, the asset management charge levied by active funds has remained broadly stable.

Now that might be fair enough, if hard-working active fund firms were already sweating hard to wring out every last penny of value for their investors, and hence had already competed each other down to wafer-thin profit margins.

But the FCA says the high levels of profitability among the firms it sampled (with profit margins averaging around 36%) indicates that:

…price competition is not working as effectively as it could be.

Or, as we might put it, that active managers are fleecing the public and providing little to show for it.

This matters because as the FCA says:

…when choosing between active funds, investors paying higher prices for funds, on average, achieve worse performance.

FCA is all for a single all-in fee

The FCA also supports a single all-encompassing fee to help investors more easily compare charges.

New regulation1 is set to introduce this for investors using intermediaries, but I don’t see why it shouldn’t be extended to all investors. The industry might argue that ordinary retail investors can’t evaluate such all-in fees effectively, but are we really expected to do better tallying up myriad opaque or hidden costs?

There is also much talk in the report about doing more to make asset managers act in the best interests of their clients – especially given that the FCA also found investors don’t appear to prioritize value for money as it thinks they should.

It therefore proposes to clarify what it expects of asset managers, to introduce more independent directors to governance boards, and to place a ‘prescribed responsibility’ under its Senior Managers Regime to make individuals more accountable.

The latter could be particularly feared – and contentious – amid fund managers.

Change is coming, ready or not

The FCA report is big and wordy, and it will take time to properly digest. You can follow the links I’ve given below for more reaction from some of the industry’s big beasts.

My own first thought was to reflect on how far we’ve come since the early days of this website.

Back in 2007 it seemed nobody was looking out for ordinary British investors. Most of us didn’t even know we were paying high charges and getting mediocre returns.

Sure, we knew the City had somehow grown over 40 years from a bunch of ex-public schoolboys taking long lunches at Rules into an full-sized economy-within-an-economy (which now manages an incredible £7 trillion of assets, according to the FCA).

But what did the evident riches of the financial services sector have to do with my pension or ISA?

Very little, the average investor assumed.

However since then we’ve had:

  • A crisis that blew away any feelings of deference towards the self-proclaimed masters of the financial universe.
  • Many years of low interest rates that have put more emphasis on costs and returns.
  • The Retail Distribution Review in the UK that swept away the most archaic and onerous charges.
  • The growth of passive investing, which has slashed costs while delivering more consistent returns to investors, and also put pressure on active managers.
  • A Cambrian explosion of information and opinion about investing spread via the Internet, not least through blogs like our own Monevator.

For all the fanfare then, you could argue the FCA is simply rushing to keep up with these forces that are reshaping the market anyway.

What’s more the FCA report prevaricates and calls for more consultation, when you might say enough already. It also declined to issue a full referral to the Competition and Markets Authority. The investment consulting industry – which plays a big role in directing pension flows – will face an official competition inquiry, but despite the FCA’s concerns about competition, the wider asset management industry has ducked it.

However it seems a bit churlish to me to complain that the regulator hasn’t turned over every apple cart just yet.

Good regulation isn’t written in haste. And given the wily ability of the financial services industry to find loopholes and leaky buckets for every million they have under management, I think it makes sense to get the regulation right.

Let’s not forget that anyone who does their research can already buy cheap trackers on the right platforms and enjoy spectacularly cost-effective globally diversified investing.

For some of us, the future is already here.

Further responses and reading:

  • Don’t forget you can read the full report yourself [PDF]FCA
  • City watchdog cracks down on industry charges – BBC
  • FCA says UK’s £7 trillion asset management industry needs radical reform – Guardian
  • The key points of the report in full – Professional Pensions
  • “A very strong signal change is on the way”Robin Powell
  • UK fund management: The reaction [Search result]FT
  1. MiFID II. []
{ 14 comments… add one }
  • 1 hosimpson June 28, 2017, 1:29 pm

    The senior managers regime already applies to banks and insurance companies. There was a big hoohaah when it was first introduced, but then the upheaval subsided, and it’s all BAU now.
    The thing about regulation is that new rules don’t necessarily mean you have to change what you’re doing day to day. If they introduce a new rule that explicitly prohibits screwing over your clients, well, you shouldn’t have been doing that before then, anyway.
    TCF regulation and the PPI miss-selling scandal are good examples of that. TCF regulations says that you shouldn’t be pushing products onto your clients that don’t meet their needs. But the regulation was introduced after the PPI issues had come to light (as opposed to PPI issues coming to light as a result of financial firms implementing the TCF)… so there may be something to be said there about stable doors and horses. Better late than never, I suppose.
    My personal view is that the FCA’s current focus on the investment management sector (which, as a customer, I wholeheartedly welcome) is a preemptive measure more than anything else. With the pension reform underway (auto-enrolment, etc.) it is expected that the sector will see a significant growth of FUM in the years to come. Also, as more people choose a flexible drawdown option over an annuity purchase in their retirement, IMs will get to hold onto people’s retirement assets longer, and the quality of admin services they provide to people with pensions in drawdown will impact a growing number of investors. So taking measures to keep investment platforms and fund managers on the straight and narrow is not a bad thing, and might be even for their own good.

  • 2 Mathmo June 28, 2017, 8:03 pm

    I saw this report and thought of you, TI. I enjoyed the revelation that — while there’s not exactly price fixing going on, the market participants suffer from high margins and aligned prices.

    Cosy little colluded space will survive for a lot longer of course, impoverishing savers, but hopefully a dwindling number of them.

  • 3 Snowman June 29, 2017, 9:13 am

    One of the shockers for me is the use of box profits see 5.1 page 25, where some asset managers are effectively using the dual pricing structure to extract charges that investors are unaware of and aren’t included in the OCF. It is unbelievable that this has been allowed and the practice hasn’t had to be disclosed in the prospectus.

    What I find scary is

    5.12 AFMs will be permitted to retain any profits made from holding positions between
    pricing points when using their own capital (‘at risk box profits’). AFMs should, if they
    wish, be able to deal as principal in the units of the funds they manage. We do not
    consider that there is a case for prohibiting AFMs from retaining the profits of this
    activity in all circumstances.

    Obviously it is reasonable for asset managers to keep ‘at risk box profits’ that result from the underlying assets going up and down, but within this is there some element of profit from the dual pricing included also?

    It also worries me that this sort of thing is going on with floated single priced funds also where the price fluctuates fully to reflect buy/sell costs by say 0.7% depending on whether there are more buyers than sellers on a day.

    The asset manager could buy units on their own account when the price is floated down one day (i.e. otherwise there are more sellers than buyers), and sell units in a few days time when the price is floated up (i.e otherwise there are more buyers than sellers). The units bought and sold by the asset manager would be limited to avoid switching the position on whether there are more buyers than sellers. The result is an instant undisclosed profit to the asset manager of 0.7% of the value of units each time they do this that the fund investors are paying for. The asset managers are able to do this as they have inside knowledge of whether the price will be floated up or down on a day.

    I don’t have any evidence that this is going on, but if some are taking box profits (albeit it appears most asset managers are acting more reasonably), but what’s to stop them?

    A number of single priced funds use semi-floating where the price doesn’t change by as much as say 0.7% from day to day, and probably the risk of this sort of thing happening here is less.

    It is perhaps a good reason to monitor tracking differences for passive funds not just OCFs.

    Incidentally the floating of single priced funds means that switching between single priced funds isn’t a cost free transaction in some cases (even for platforms that don’t charge for fund switching) especially where full floating of the price is going on, because probabilistically you are more likely to sell/buy when the price is floated down/up.

  • 4 Snowman June 29, 2017, 9:18 am

    Sorry should have made it clear my reference above is to the consultation document not the main report


  • 5 FI Warrior June 29, 2017, 12:20 pm

    I wonder why after decades of a blind eye something may actually happen now, obviously we the patsy punters’re missing most of the pieces of the puzzle so can’t see the full picture. The masses have been being quietly diddled out of their pension savings for ages without realising it or any interference, perhaps the establishment is getting nervous about the political heat of even their own voters hitting pension age then finding out they’re poor.

    My money’s on the usual formulaic farce, so as with every similar scam of the day they’ll drag it out until enough relevant observers lose interest, then water down any real restrictions; (PPI’s winding down now innit) it’s so easy. Even if there’s a symbolic slap on the wrist for the p*ss-takingly obvious players in the industry, (wongaboys) the regulations will be toothless and the fines will just be a one-off tax that leaves a level of profit guaranteed to ensure it’ll be business as usual when the dust settles. Britain’s open for business all right. Plus ca change, etc., etc.

  • 6 The Investor June 29, 2017, 2:07 pm

    @Snowman — The Final Report suggests the FCA is going to try to stop this practice, although as with much of its findings it doesn’t seem to have quite made its mind up yet. Per point 1.24 on page 6:

    We are consulting on requiring fund managers to return any risk-free box profits to the fund and disclose box management practices to investors.

    I’m no expert on the mechanics of fund management, but I expect funds will argue that box profits arise out of providing liquidity in their funds, and that sometimes funds win and sometimes they lose from providing such liquidity. (Will investors therefore take the losses, too?) I could be wrong, but that’s my hunch. Any fund managers reading (and there are a few 🙂 ) might be able to explain more explicitly the pros and cons.

    It’s a bit like the push from lobbyists for funds to levy at the outset a stated transaction fee/cost, as part of any explicit all-in charge. It sounds sensible, but funds can reasonably argue they can’t know that cost up-front, partly because they don’t know how market conditions could prompt them to trade, and partly because changes in Funds under Management would influence the cost borne by individual investors on a percentage basis. Of course the FCA may argue tough tomatoes, any business has variables, so make your best estimate as a fixed amount and then manage the fund accordingly, and profit in some years and make losses in others.

    I am more sanguine about cost transparency than the likes of Robin Powell etc. As far as I’m concerned, the explicit fees should be known, and the other fees should show up as a drag in the returns. I do see the opposite argument and I think it has some merit, but I think returns are the prime barometer if you’re going to go down an active fund route (which we all know you probably shouldn’t.)

    Where so called charges are more a cost of business (e.g. transaction costs) I wonder why other businesses aren’t held to the same high standard. E.g. the cost of a fancy cup of coffee is maybe 10% coffee beans. Should we get a breakdown of every last cost on the bill at Starbucks?

    As I say a bit contrary of me to think this way probably — and I suspect that for instance @TA feels differently. Basically I think consumers should be held more responsible for their actions and decisions.

    It’s not like the information isn’t out there these days — there are about 2 million words on this website alone, for example, of which perhaps a million is dedicated to passive investing. I am getting a bit “bah humbug” about financial service consumers these days.

  • 7 Ollie June 29, 2017, 6:28 pm

    In addition to the report from the FCA, what I’ve never understood is why the pension funds in the UK are provided and fixed by the employers and as an employee, I don’t have the choice to choose what fund to use.

    I can’t ask my company to contribute to whatever fund I choose, my company imposes it’s fund over me.

    Isn’t this something that might be stifling competition and that should be analyzed by the FCA?

  • 8 James June 29, 2017, 9:58 pm

    All I care about is getting rid of exit fees.

    Price transparency is all well and good, but if exit fees (which are terribly poorly advertised) stop you being able to take advantage of cheaper offers then what’s the point?

    Exit fees in any guise are anti competition. Businesses should try and retain customers via good service and value, if they can’t provide that then frankly they don’t deserve to hold onto their customers

  • 9 NorthwestIan June 29, 2017, 11:55 pm

    The ONS says the UK pension industry has 4 trillion invested, all of which will, I guess, be under management. Let’s say the pension industry pays 1.5% in charges so that will be 60 billion transferred each year. Now, I can’t find figures for how much retail investors have invested but it’s going to be small beer compared to the large pension funds and insurance companies. When I looked at company trustee pension scheme reports I found that most of these were paying fees at or around 1-2% and surely it’s these rates that set the markets – not us retail investors who will never have the clout to influence the market makers. It’s good that the FCA is shining a light onto these charges but I think the market will only change when there is pressure from the pension trustees asking exactly what do we get for this payment of 60 billion each year?

  • 10 The Wealth Builder June 30, 2017, 3:38 pm

    1.5% in fees for a wholesale client is massive. Only really small or badly run schemes would have to accept that.

    My occupational pension fund (c£1bn) has a default fund with fees of 0.38%, and a number of self-select funds with fees as low as 0.07%.

    Most of the institutional pension and insurance money is held by a few big players who are usually pretty sharp at keeping a lid on costs.

    I’d be interested to learn which schemes have such high fees if you’re willing to share?

  • 11 Chris July 1, 2017, 11:48 am

    I think there is a wave of pension funds being realigned to lower fees at the moment. My work fund just moved to a low fee structure.

    It is worrying that the prices in the UK are much lower than we get slammed with in Australia in our pension funds (compulsory 9% contribution). At least we have choice of provider but they all charge more than options in the UK. The FCA letter is a good prompt for some letter writing.

  • 12 Jeff July 1, 2017, 5:57 pm

    I have a couple of concerns with platforms.

    1 They can lure us in with a good deal & then hoik it away. One example, is AJ Bell where I started a SIPP that had zero annual fees. They make the money from trades. Then they introduced fees, so I was paying £100 a year. Then they modified the fee structure, so I now could pay £300 a year. Another example is the mark up on foreign currency trades, which typically used to be under 0.5% and is now typically 1.5%.

    2 There is a lack of portability, so if providers do increase the charges after I join, it is incredibly difficult to move. And by all accounts, it can take months.
    The FCA should be taking a couple of actions:
    (i) Ensuring all providers facilitate “in specie” transfers that must have the account down for no more than 48 hours.
    (ii) Transfer fees should be capped. Logically the cap should be no higher than their lowest applicable dealing fee.
    (iii) Where the provider has made an above inflation change to charges, they must allow zero cost in specie transfers to another provider for at least 1 year.

    It’s about time they sorted this out. I have seen no end of investigations into banks, yet it’s an absolute doddle to move to a new bank. Even in the old days, it was never particularly difficult. About time platform providers were investigated.

  • 13 Jeff July 1, 2017, 9:00 pm

    I also agree with Ollie on company pensions. My company pension is on a Standard Life platform which offers a few Standard Life funds and some token unattractive other ones.
    Where is the full market choice ?

  • 14 PA July 2, 2017, 2:20 pm

    @Jeff – agree with your list of platform issues.

    It is more tricky for those ‘on the cusp of retirement’ where you aim to have low costs for last few years of accumulation and then free/low cost of drawdown. Costs can change for both accumulation and drawdown so need to pick best overall.

    I would also love to know why the platform costs vary for holding IT/shares against OIEC/fund. Computer systems do most of the work, development costs should reduce over time/scale yet costs vary greatly.
    Example HL ISA – IT/ETF/shares 0.45% capped at £45 whilst funds 0.45% uncapped

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