The damning report concludes that the full scale of hidden costs is simply not known, citing data from LCP that shows two thirds of fund managers are unable to provide information on transaction costs.
The report draws on two other reports, on by Rajiv Jaitly, a global risk consultant and a member of the expert panel that advised the 2013 OFT study into DC workplace pensions, and a second by a team led by Mr David Pitt-Watson, an executive fellow in the finance department at London Business School and a former director at Hermes, the fund manager.
The Pitt-Watson team report found the main reason costs cannot be disclosed is because many costs are not properly measured or declared.
The FSCP reports that even institutional investors of multi-billion pound pension funds sometimes do not know the full costs of investing, meaning retail investors have virtually no chance of knowing what they are paying. It points to reports that Railpen Investments, a £20 billion pension scheme, took many months and encountered great difficulty in deriving an estimate of the scale of its total fees, which it concluded were around five times its headline fees.
The FSCP report calls for greater transparency than is being mooted by the Mifid 2 proposals, due to take effect in January 2017, which do improve transparency. It also argues the IMA’s Statement of Recommended Regulatory Practice (SORP), which is compulsory for UK authorised funds, and requires disclosure of operating costs, dealing commissions and stamp duty but stops well short of the disclosure envisaged by MiFID II, is welcome but does not go far enough.
The FSCP proposes investment managers be required to quote a single and comprehensive annual charge, including estimates of forward costs like transaction charges. All other costs, currently deducted by the investment manager directly from the fund, would be borne by the investment management firm. This would enable consumers to compare different firms’ charges, and also act as a powerful incentive on firms to improve efficiency.
It also proposes investment managers could have a strengthened legal obligation to put the interests of their customers first, the fiduciary duty because the current regulatory requirement to ‘treat customers fairly’ does not tackle the multiple conflicts of interest in the investment industry revealed by the research.
FSCP chair Sue Lewis says: “Investment managers in the UK have stewardship of £1 trillion of retail consumers’ money. The combination of poor disclosure, weak governance and multiple conflicts of interest means that competition in the investment market is not working in the best interests of consumers.
“The problems our research has identified are long standing, and need fixing urgently. People are depending more and more on investment to deliver their long-term financial wellbeing, especially in the light of the recent pension reforms. It is completely unacceptable that consumers do not know what firms are charging them to manage money on their behalf, and cannot compare different offers. While we recognise that the industry is working to improve disclosure, this does not go far enough.”
Panel member Dr Debbie Harrison says: “We are suggesting putting the risk of managing the costs of executing trades onto the fund manager. The FCA was clear that they were concerned fund managers were less diligent in their oversight of costs incurred by the fund than they were about their own costs. Investment managers will argue they cannot know what the costs of running funds will be from year to year. But these are big organisations that know what their outgoings are likely to be.”
LCP partner Andy Cheseldine says: “We welcome this comprehensive analysis of the market from the FSCP. Many of the issues raised have been picked up by the OFT and DWP in their various ongoing reviews and it is very helpful to have the bibliography of relevant research fully documented for reference. The DWP consultation “Better Workplace Pensions: Putting savers’ interests first“ which closed last week made it clear that transparency of transaction costs is a pre-requisite for good governance and value for money.
“As one of the authors, Rajiv Jailty says “the short-hand term ‘funds’ masks very important differences between the types of structures that can be used. These can have significant implications for investors’ outcomes, particularly in relation to costs and risks. Even professionals in the market may not understand some of the complexities”. Our experience of the market is consistent with this view.
“It is disappointing, after so many independent reviews and reports over so many years, that transaction costs are still so difficult to quantify and obtain. These costs should be obvious internal reference criteria for the efficiency of portfolio management by fund managers. And if the costs are being monitored internally, there is no reason they should not be disclosed. We will soon be publishing our 2015 version of our LCP investment management fees survey and it is clear there has only been limited progress on this front.
“We do not agree with all of the conclusions of the paper. For instance the proposed single charge (including transaction costs) would certainly simplify and clarify costs, but it would also introduce new and even more dangerous problems in portfolio management. However it is important that the industry debates all possible mitigations of high costs so as to allow accurate measurement of value for money.”
IMA chief executive Daniel Godfrey says: “The IMA’s purpose is to make investment better for investors and a key part of that is to make it as easy as possible to understand the cost of investing and how this affects returns. Although cost disclosure by UK funds is already very detailed and comprehensive, it also needs to be understandable. This is not a simple task and success has eluded both regulators and the industry for many years.
“But the IMA has now developed a new measure that tells consumers, in pounds and pence, exactly how much a unit in a fund grew over the course of a year and how much it cost to achieve that performance. Every penny spent by the fund is included in this figure and so it provides a simple, accessible, all-inclusive measure of all costs. Nothing is hidden and nothing is left out.
“Pounds and pence disclosure goes beyond any regulatory or legal requirement and is a big step forwards for consumer understanding. We expect it to be in place next spring, but there is more to do. The IMA is working on ways to measure and explain the significance of both portfolio turnover and spread and the part they play in returns. The IMA will also amend our codes to require clear and simple disclosure of research costs where these are met from dealing commissions paid by funds.
“Investment managers play a central role in the financial wellbeing of millions of individuals in the UK. They help individuals achieve their financial goals – from achieving the things they dream of having or doing to being confident that they will enjoy a decent standard of living as they get older. This is a serious responsibility and these individuals are our primary concern, always. Their success is paramount and investment managers must always place the interests of those individuals ahead of their own.
“We will work with the FSCP in developing our proposals for simple and comprehensive disclosure so that consumers will be able to have confidence that investment managers live up to these very high standards.”
