16 Apr 2012
The refusal of retail managers to volunteer fee cuts despite years of poor returns is seriously damaging their reputation, as low-cost providers compete for business and regulators turn the screw.
It took determined intervention from the Financial Services Authority to stop kickbacks being paid by managers to distributors from the start of next year.
Elsewhere, the True and Fair Campaign generated by Alan and Gina Miller, the husband-and-wife team behind exchange-traded fund manager SCM Private, wants to supply investors with an online analysis of every cost incurred by the retail funds they own to produce a single cost.
The Millers say investors should ask managers for data such as total expense ratios, performance fees over two years, dealing costs over two years, stock lending profits and platform commissions.
They can then calculate the amount investors are paying to managers each year.
Uncertainties must attach to calculations based on prior performance. Richard Saunders, chief executive of the Investment Management Association, disputes the relevance of certain data points.
But Gina Miller said: “It is better to get 90% accuracy, through a single number, than live in uncertainty.” She is talking to potential distributors.
Ed Moisson, a research head at data provider Lipper, said: “SCM’s move will help to take the debate to the next level.”
According to SCM, total investment costs can be 3.5% a year, or higher than the prospective equity returns of 3% a year seen as likely by Elroy Dimson of the London Business School.
But Saunders said: “The number of 3.5% is not a number I recognise. The basic total expense ratio of 1.7% isn’t out of line with costs to consumers by our calculations.
And that will fall as adviser commissions drop away.” Accountancy firm Deloitteexpects these cuts to average 50 basis points.
Saunders agrees the industry is facing a severe challenge and needs greater transparency, which the European Securities and Markets Authority is seeking to encourage.
The decline in fortunes for retail funds is in sharp contrast to the 1980s and 1990s, when the business built an impressive performance record on the back of a powerful bull market.
In those days, active managers were perceived as the best route into global equity markets, taking full advantage of “hot” initial public offerings and share underwritings.
Research-driven US managers gained an edge, as markets rewarded their endeavours in a logical fashion. And central banks cut rates to support the system every time a crisis blew up.
As long as managers were able to produce double-digit returns, myopic retail investors scarcely noticed fees – hidden or otherwise.
When the Financial Services Authority forced through its Retail Distribution Review, investors barely raised a cheer. But Saunders reckons investors will appreciate the difference this time.
He agreed managers need to be accountable for underperformance. He said: “Periods of poor performance can be prolonged. Fifteen years can be typical.” Global equities, for example, have only achieved a median annualised return of 1.2% this century, according to Morningstar.
Even managers in the upper quartile only generated 2.7%, suggesting they are failing to cover their costs by SCM’s estimates. Research is failing to add value and there is a lack of corporate actions from which managers can profit.
The FSA has cut its minimum projection for equity returns for retail products to 4%. But forecasting is a dark art. Paul Sweeting, European head of strategy at JP Morgan, said: “There is a significant risk that by the time people realise they have insufficient assets to fund a comfortable retirement, it’s too late to do anything about it.”
Managers have contrived to increase the pain of retail clients by refusing to cut their fees. According to Lipper’s Moisson, 90% of active retail funds in the UK pushed up their fees in the 10 years to October 2011.
Around 80% of European cross-border active equity funds rose. Fee rises averaged 30 basis points across Europe.
Peter Smith, head of investment policy at the FSA, expressed surprise to Bloomberg last month that fees had gone up in what is supposed to be a competitive environment.
Focus on fees
Terry Smith’s Fundsmith has promised to charge no more than 1% for its global active fund, with minimal stock turnover.
Exchange-traded funds are making inroads by costing investors less than 50bps and helping them exit markets quickly at the first sign of trouble.
Their development follows the adoption of passive strategies by institutions and consultants that became weary of active fees for poor performance.
They initially backed cap-weighted indices and now they are buying into lists of stocks with common characteristics, such as low volatility. One analyst said: “Global managers have effectively been disintermediated by the index providers.”
ETF managers are hoping to penetrate the European retail scene to the same extent as in the US, where a fifth of new money goes in their direction each year, according to Cogent Research.
Posted By: True and Fair, 8:56 am