After the banks, it’s the turn of asset managers to face heightened scrutiny from regulators. On 7 April 2016, the Financial Conduct Authority published the results of a thematic review (TR16/3) on whether asset managers are delivering what they have promised to investors. The financial press has focused on findings that some active funds were "closet trackers," that is tracking an index or investing a material part of their portfolio passively and without adequate disclosure to investors. All this while charging high fees for alpha performance.
The UK's conduct regulator looked at 19 UK fund management firms responsible for 23 UCITS funds of different sizes with varying investment strategies and four segregated mandates for institutional investor portfolios.
In line with the FCA's Smarter Consumer Communications initiative, the review scrutinised whether investor needs were properly reflected when developing investor communications. Other areas of focus were whether funds are doing what it says on the tin and whether they are being appropriately distributed. The review gives examples of good and poor practice.
So what were the FCA's key findings?
- The FCA found five potential examples of "closet trackers"- funds which were designed to passively track an index- where the strategy had not been disclosed to investors. Where a fund is "structurally constrained by policy or practice" this should be disclosed to investors. The FCA accepts that asset managers may from time to time choose to track an index for a short period to limit risk, but this practice and the benchmark must be disclosed to investors to allow them to judge risk and cost.
- Firms need to have clear product descriptions to allow investors to understand a fund's investment strategy, how fund managers invest on their behalf and the risks involved in investing. The FCA noted that firms should be providing customers with sufficient detail about a fund, in a clear and jargon free manner that they can understand, and the information should be consistent in marketing and disclosure documents. The good news is that the FCA found that most firms provided sufficient information about fund strategies, characteristics and risks to allow customers and financial advisers to make informed investment decisions. Less positively, the descriptions given by some key investor information documents (KIIDs) did not match how they were managed. For example, firms had failed to disclose the use of benchmarks or exposure to currency risk.
- In particular, investors must have clear information so that they can assess therisks inherent from a fund's investment strategy. Positively, most firms disclosed their key risks although the FCA had some concerns around the adequacy of a number of KIIDs which did not properly explain the consequences of risk (i.e. that the value of investments might go down).
- The FCA reminds managers that they must maintain adequate managementoversight of funds that are no longer actively marketed to investors. The sample included four funds which were not actively marketed and the FCA identified issues in all of them.
- The FCA found that two funds were available on execution-only platforms when the funds were only meant to be available with advice - the firms in question were not aware that the funds could be accessed this way. The FCA reminds firms and distributors of the need to ensure that appropriate distribution routes are being used.
- Firms were also reminded that they should monitor sales patterns against the fund's target markets and identify unusual patterns, as this can indicate problems in distribution resulting in inappropriate sales, This is irrespective of whether customers are advised or not.
What are the principal takeaways for asset managers?
- All relevant aspects of investment strategy must be monitored to see that funds are managed in accordance with the marketing and pre-investment disclosure documents Firms should review KIIDs to ensure they disclose material risks clearly.
- Firms must adequately disclose passive strategies.
- Investor information must be "clear, fair and not misleading" and take into account the target audience. Firms should consider "signposting" complex funds with a recommendation to investors to seek advice.
- Firms must obtain sufficient information from distributors to allow them to monitor and see that their products are appropriately distributed. Firms should check whether contractual documentation with distributors allows for this.
- Care needs to be exercised in respect of non-actively marketed funds to ensure that management oversight is not neglected.
Senior managers should review all the review's findings, consider whether any of the concerns raised by the FCA are reflected in their own firm's operations, and take action to minimise poor customer outcomes as required. Individual accountability will move up the regulatory agenda with the roll out of the senior manager's regime to asset managers in 2018. The FCA did not indicate that it was taking any enforcement action against those firms in the review where failings were found, but all firms can expect to see these issues come up during routine supervision.
In addition to this thematic review, the sector is awaiting publication this summer of the interim findings of the asset management market study. A final report is due in early 2017. As well as barriers to innovation and technological advances, the study is considering how asset managers compete to deliver value, whether they are motivated and able to control costs, and the effect of investment consultants on competition for institutional asset management.