Value for money in the asset management industry is a key theme for regulators in many jurisdictions. For example, in the European Union, the European Securities and Markets Authority (ESMA) has identified retail investment products’ cost and performance as a Strategic Supervisory Priority for national competent authorities. ESMA is currently conducting a common supervisory action on the supervision of costs and fees in UCITS funds, which includes compliance with the obligation of not charging investors undue costs.

In the United Kingdom, since 2019, asset managers have been required to assess annually the value that their authorized funds deliver to investors and publish a summary of their assessments. The Financial Conduct Authority (FCA) recently published feedback from its first formal review of the implementation of these rules. This article discusses the FCA’s key findings, as well as our own observations based on industry reports and our work with firms in this area. It draws out lessons relevant for firms globally as they consider how to assess value for money.  

The FCA’s value assessment framework requires asset managers to evaluate whether a fund’s charges are justified based on the overall value delivered to investors, considering the following seven assessment criteria at a minimum:

• The range and quality of services provided to investors;
• Investment performance over an appropriate timescale, based on the fund’s investment objectives, policy and strategy;
• The costs incurred by the asset manager in providing the services;
• How the fund’s charges compare with similar funds in the market;
• How the fund’s charges compare with other services provided by the asset manager (e.g., institutional mandates of comparable size with similar investment objectives and policies);
• Whether the asset manager benefits from economies of scale and whether these benefits are shared with fund investors; and
• Whether investors in some share classes pay higher fees than those in other share classes with substantially similar rights.

These criteria are similar to the criteria set out by ESMA on how firms should design a structured pricing process, although the FCA’s framework includes explicit consideration of profitability, economies of scale and comparable services provided by the asset manager.

Following the United Kingdom’s first round of value assessments, an Investment Association study of nearly 1,500 funds found that action was considered necessary in 21% of funds. Poor performance was the biggest contributor to poor value, with performance being a concern in 85% of funds where action was taken. How a fund’s charges compare with similar funds in the market was the next largest contributor, with nearly a third of poor value funds failing this criterion. Quality of service was the least likely criterion to be deemed poor value, with only eight funds in the study reporting issues.

Findings from the FCA’s review of firms’ value assessments

Key themes in the FCA’s feedback from its review include:

• Some firms assessed value against a lower standard than investors may reasonably expect. Many active funds only assessed value against vague fund objectives such as achieving “long-term capital growth”, even though they charged fees in line with active management and rewarded fund managers based on a comparator benchmark. Firms must consider what investors would reasonably expect from the fees they pay and the fund’s investment policy and strategy. Some firms justified the underperformance of funds over several years due to the investment style underperforming the market; however, they had not clearly disclosed the risks of relative underperformance over longer time periods to investors. Some multi-asset funds and funds of funds only assessed value against other multi-asset funds or funds of funds, without considering that investors typically pay higher fees for these fund types to achieve better risk-adjusted returns than with a cheaper fund.
• Many firms’ analysis was insufficiently granular, leading to poorly evidenced conclusions. Some firms assessed value only at the firm or fund level rather than at the share class level. This meant firms potentially overlooked poor value in some share classes. For example, some firms only assessed net performance for the wholesale share class with the lowest charges, rather than considering that net performance will be lower for share classes with higher charges.
• Some firms over- or under-emphasized certain value indicators. For example, some frameworks gave a very heavy weighting to a fund’s performance, which meant other indicators like profitability were not escalated to the board. In other cases, little emphasis was placed on poor performance.
• Many firms assumed current industry fee and profitability levels were acceptable, even though the FCA has found that the market is not competitive. When assessing profitability, some firms assumed typical existing profit margins were justified, with changes only considered for material outliers. However, in its asset management market study, the FCA found that typical industry profit margins were not consistent with competitive outcomes. Also, some firms assumed that existing fund charges already reflected economies of scale being shared with investors without any justification for this. Overall, firms were typically less active in analyzing the fees paid for asset management and distribution services than those paid to outsourced service providers.
• Independent non-executive directors (INEDs) often did not provide sufficient challenge. Some of the INEDs on the board did not provide a robust challenge and appeared to lack sufficient understanding of relevant fund rules.

How can firms improve their value assessments?

Our own analysis, in addition to the FCA’s findings, has identified some key steps that firms can take to improve their value assessments:

• Ensure that a standardized process for assessing value across all funds does not prevent fund-specific issues from being considered—for example, the value assessment must consider each fund’s purpose, objectives and investment strategy.
• Articulate clearly what constitutes poor value—for example, while it is inevitable that active funds will sometimes underperform the market, how long or by how much can a fund underperform before it is deemed poor value?
• Ensure the data used in the analysis is fair and accurate—for example, we saw some firms using very broad categories of funds for peer group comparison, when many of the peer group’s funds were not genuinely comparable.
• Include quantitative information in the published reports where relevant.
• Give board members plenty of opportunity to challenge the assessment methodology and document any challenge appropriately.
  

What are the effects of the value assessments?

Overall, the value assessment process has succeeded in bringing firms’ attention to the value they deliver for investors. Firms have applied a range of remedies, including fee reductions, moving investors into cheaper share classes, closing funds, or changing investment strategies or teams. However, so far, we have not seen widespread corrective measures. An analysis of 968 funds by Boring Money found that only 3% of funds were deemed poor value, although a further 18% were being monitored or had some fee reductions implemented.

The FCA requires firms to publish a summary of their value assessments and external scrutiny can put pressure on firms to provide better value. So far, the (trade) press has picked up on several reports, giving positive coverage of fee reductions and criticizing unconvincing reports.

Financial advisers could use these reports to aid fund selection. However, a study by the Lang Cat consultancy of 565 financial advisers found that only 6% used the reports in the first year. However, this may increase as the process becomes more established.

Another potential audience is retail investors. Research by Boring Money found that of over 3,000 UK retail investors, 19% had read at least one report, of which 58% said they were “somewhat useful” and 32% said they were “very useful”. The number of retail investors reading the reports could grow if the reports were consistently displayed prominently on firms’ websites, which is currently not always the case.

In its asset management market study, the FCA found evidence of weak price competition (particularly for active retail funds) and sustained high profit margins, suggesting some funds were not offering value for money. There has been a downward trend in fees in the sector since then (see Chart 1), and the FCA cites this as evidence that its measures (including value assessment requirements) may be leading to improvements in competition. Nevertheless, the average profit margin is still 36%, which raises questions about whether some funds are not delivering adequate value to investors. Given the increased pressure from the FCA and external scrutiny on firms’ value assessments, we expect that the number of corrective remedies implemented by firms may increase.