At a glance 

The FCA has published the findings of its multi-firm review of authorised fund managers’ (AFMs’) assessments of their funds’ value. The FCA found that most AFMs had not implemented adequate value assessment arrangements. Common pitfalls included: 

  • Many firms assumed that current industry fee and profitability levels are acceptable, even though the FCA has previously found that typical industry profit margins are not consistent with competitive outcomes.  

  • Many firms’ assessments were insufficiently granular, leading to poorly evidenced conclusions.  

  • Some firms assessed value against a lower standard than what investors might reasonably expect based on the fund’s charges and how it has been marketed. 

  • Some firms under- or over-emphasised certain value indicators.  

  • Independent non-executive directors (INEDs) often did not provide sufficient challenge on the assessments.  

  • The FCA intends to review firms again within the next 12 to 18 months to assess how well they have reacted to its feedback. It will consider other regulatory tools should it find firms are not meeting the standards it expects.

Our own analysis indicates that firms can take a number of steps to improve their assessments in addition to reviewing the FCA’s findings. These include:

  • Being clear on what constitutes poor value – for example, at what point does underperformance imply poor value? 

  • Clearly explaining how conclusions have been reached – for example, how peer groups have been determined. 

  • Including quantitative information in the published reports where relevant. 

  • Displaying the reports prominently on their website. 

Our analysis indicates that the value assessment process has succeeded in bringing firms’ attention to funds that lack value, but that so far there does not appear to be evidence of widespread corrective measures. We may see more remedies being applied in the future as the FCA puts pressure on firms and external scrutiny of the reports could increase. 

Overview 

The FCA has published the findings of its multi-firm review of AFMs’ assessments of their funds’ value. Between July 2020 and May 2021, the FCA visited a sample of 18 AFMs. It found that most of these firms had not implemented adequate value assessment arrangements.  

In this blog, we summarise the FCA’s findings and discuss what the rules have achieved so far and whether they will drive better value for investors in future. We have also attached a slide pack (scroll to the bottom) which sets out our views in more detail, including on each of the seven value indicators set out by the FCA (performance, economies of scale, quality of service, AFM costs, comparable market rates, comparable services and share classes). Also, for a more in-depth analysis on the value indicators of performance, economies of scale and quality of service, please see our second blog here. 

The FCA’s findings 

Overall, whilst there have been some good signs of progress, it is clear that AFM Boards have a lot more work to do to meet the FCA’s expectations. Key themes in the FCA’s feedback include: 

  • Many firms have assumed that current industry fee and profitability levels are acceptable. This is not good enough for the FCA. When assessing profitability, some firms assumed that typical existing profit margins were justified, with changes only considered for material outliers. However, the FCA found in its asset management market study that typical industry profit margins were not consistent with competitive outcomes. When considering economies of scale, 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 analysing the fees paid for asset management and distribution services than they were for fees paid to outsourced service providers. 

  • Many firms’ analysis was insufficiently granular, leading to poorly evidenced conclusions. Some firms assessed value only at firm or fund level rather than at 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 may be lower for share classes with higher charges. Many firms did not assess the profitability of their funds, focusing purely on how their fund charges compared to competitors. 

  • Some firms assessed value against a lower standard than what investors might 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 need to consider what investors would reasonably expect given the fees they are paying and the fund’s investment policy and strategy. Some firms justified funds underperforming for some years on the basis that the investment style had under-performed the market but had not clearly disclosed the risks of relative underperformance for long 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 the fact that investors typically pay higher fees for these types of fund with the aim of achieving better risk-adjusted returns than they would get with a cheaper fund. 

  • Some firms over- or under-emphasised certain value indicators. For example, some frameworks gave a very heavy weighting to a fund’s performance, which meant that other indicators such as AFM costs or economies of scale were not escalated to the AFM Board. In other cases, little emphasis was placed on poor performance. 

  • INEDs often did not provide sufficient challenge. Some of the INEDs on AFM Boards did not provide the robust challenge the FCA expects from them and appeared to lack sufficient understanding of relevant fund rules. Since the FCA introduced requirements to recruit INEDs with the aim of increasing independent challenge, we expect the FCA to put greater pressure on firms to ensure they have recruited INEDs who are sufficiently expert and independent. 

How can firms improve their value assessments? 

Our own analysis indicates that in addition to reviewing the FCA’s findings, some of key things that firms can do to improve their value assessments include: 

  • Being clear on what constitutes poor value – for example, how long can a fund underperform for or by how much before it is deemed poor value? 

  • Being clear on how they have arrived at their conclusions - for example, explaining how they have determined peer groups for comparing value. 

  • Including quantitative information in the published reports where relevant, including in areas such as performance relative to a benchmark, fund charges and quality of service. 

  • Displaying their reports prominently on their website so that retail investors notice them. 

We set out our views in full in the slide pack attached below and our blog on the value indicators of performance, economies of scale and quality of service. The points we raise will be particularly relevant to individuals who are responsible for an AFM’s value assessments under the Senior Managers and Certification Regime.  

What have the value assessments achieved so far?  

Overall, the value assessment process has succeeded in bringing firms’ attention to the value they are delivering for investors and has increased external scrutiny of value. 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. 

Will the value assessments drive better value for investors in future? 

The FCA has made it clear that firms need to challenge themselves more on the value they deliver to investors. Firms that assume current fee and profitability levels are acceptable or assess value against a lower standard than investors might reasonably expect are going to face tough questions from the FCA. This is likely to drive firms to consider implementing remedies on a wider range of funds. The FCA intends to review firms again within the next 12 to 18 months to assess how well they have reacted to its feedback. It will consider other regulatory tools should it find firms are not meeting the standards it expects.  

While the primary aim of the value assessments exercise is to drive more scrutiny by the AFM Board, and the internal assessment of value is typically far more detailed than the published report, external scrutiny of the published report can also put firms under pressure to tell a convincing story. The level of external scrutiny can therefore also be a driver of better value. So far, the (trade) press has picked up on a number of reports, giving positive coverage of fee reductions and moves to cheaper share classes, and criticising reports that are unconvincing. Financial advisers could use the reports to aid fund selection and demonstrate value to investors. However, a study by the Lang Cat consultancy of 565 financial advisers found that only 6% of advisers used the reports in the first year, 27% did not know the reports existed, 39% of those who had read the reports found them neither informative nor useful, and 50% did not know whether the reports would be of use in the future. These figures may improve over time as more advisers become aware of the reports and the FCA pushes for better quality assessments.  

Another potential audience is retail investors. Research by Boring Money found that of a sample 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 increase if the reports were consistently displayed prominently on firms’ websites. While many are prominently displayed, others are hard to find. In the CFA UK’s study of 145 firms, it could only locate reports for 75% of its target sample.  

The reports vary significantly in length, content and presentation style. This makes it more difficult to compare the value of funds across different firms. The FCA has deliberately not been prescriptive about how the reports should look as it wants AFM Boards to take responsibility for the assessment. However, we think it would be useful for the industry to develop best practice standards on the minimum factors that should be considered under each value indicator to aid comparability.  

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 that some funds were not offering value for money. While average fund fees have reduced since then, the average profit margin is still 36% which raises questions about whether there are funds that are not adequately delivering value to investors.  Given the increased pressure from the FCA and external scrutiny, we expect that the number of remedies may increase.  

Conclusion 

While the value assessment process has brought firms’ attention to the value they are delivering for investors and resulted in some corrective measures, we are yet to see widespread remedies. The FCA has made it clear that it is not satisfied with the quality of the assessments that it has seen so far, and we expect it to put continuing pressure on firms to provide better value for investors. External scrutiny will also make it harder for firms to justify poor value funds. We expect to see a gradual, but material increase in remedies being introduced.  

For further details on all the seven indicators of value, see our slide-pack below.