New push has U.K. firms looking hard at their businesses

A new effort by the U.K.'s financial services watchdog to ensure that money managers are delivering value to their institutional and retail investors is prompting firms to inspect the performance of funds and look to consolidate offerings to achieve greater scale.

Some sources said more intense scrutiny from the Financial Conduct Authority in the first half of 2020 could lead more managers to consider shutting down strategies with similar objectives and trimming performance and annual management fees as well as third-party expenses such as audit costs.

The FCA wrote to the CEOs of money management firms operating in the U.K. on Jan. 20, urging them to change fee structures and investment strategies that are not benefiting investors.

Wanting to see firms effectively and regularly assess their offerings, the FCA will seek confirmation that boards challenged senior executives to improve outcomes for investors. "We will seek evidence of meaningful challenge at authorized fund managers' boards on proposals made by the executive — including on costs, fees and product design," the FCA said in the letter.

The letter stems from the regulator's earlier investigation into the business of money managers — the Asset Management Market Study, which in 2017 concluded that U.K. investors could receive better value for money from their managers.

As a result of that study, firms have been required since Feb. 4, 2019, by the FCA to review their funds' performance objectives and, since Sept. 30, state on their websites through an annual value assessment report how they contribute to their investors' goals. Firms must publish their value assessment report in their long financial report within four months from the end of the last annual accounting period at the latest.

Andrew Glessing, head of regulatory compliance at Alpha Financial Markets Consulting PLC in London, who used to supervise money managers at the FCA, said the regulator's move not to prescribe a template for how it wants firms to show value assessment was deliberate. "The FCA doesn't want managers to collude," he said.

In the first half of 2020, the FCA will be examining managers' efforts to assess if:

• Their funds' performance was in line with benchmarks.
• They have been providing investors with quality services.
• Their funds could benefit from merging.
• Their fund fees and third-party costs could be reduced.
• They offered investors rates and services comparable with market rates and services.
• They adopted fair fee structures for all types of investors.

Those responsible for value assessment reports are senior executives appointed by money management firms under the Senior Manager and Certification Regime, a separate U.K. regulation that took effect Dec. 9. The new law, among other rules, has armed the FCA with a power to fine individual directors at money management firms if they failed to show how they have protected their investors' interests.

Sources said the FCA's push is aimed at leading managers to reduce annual management fees and third-party costs as well as identifying to their investors how well each of their funds is performing. The FCA is particularly targeting managers that sell passive funds disguised as active funds, known as "closet trackers," sources added.

Steve Kenny, commercial director at Square Mile Investment Consulting & Research Ltd. in London, said the FCA wants to improve how managers are communicating to investors in fund fact sheets because often "funds' objectives in prospectuses are too opaque and they are incomprehensible for investors."

Mr. Kenny added that with managers having to assess the performance vs. fund objectives, they may start to question if they need six or seven U.K. equity funds. "If you consolidate them into one, the fund costs would come down for investors," he said.

Mr. Kenny, whose firm was hired to develop a value report for Rathbone Unit Trust Management Ltd., highlighted that the assessment of Rathbone's strategies made the firm identify underperforming funds and make changes to its offering.

Rathbone, which had £7.4 billion ($9.7 billion) in assets under management as of Dec. 31, said in its value report that "significant resource" had to be invested to address the FCA's value assessment criteria. The manager subsequently switched all of its retail investors into institutional funds, moving investors into a cheaper share class.

Mike Webb, London-based CEO of Rathbone Unit Trust Management Ltd., said in a telephone interview that the firm identified two funds to be underperforming their respective benchmarks due to significant exposure to U.K. stocks, impacted by the uncertainty resulting from the U.K.'s departure from the European Union.

One fund, Rathbone Global Alpha Fund, which had AUM of £121 million as of Dec. 31, delivered a 60.19% return over five years through Dec. 31 vs. 62.88% returned by its benchmark. Mr. Webb said the fund's only client chose to terminate Rathbone as a manager, and the fund will close in 2020. He declined to name the client.

Also, Rathbone U.K. Opportunities Fund, with AUM of £47 million as of Dec. 31, underperformed its benchmark FTSE All-Share index over a three- and five-year period, returning 18.48% and 43.04%, respectively, vs. 22.01% and 43.84% by the index.

In the value assessment report, the firm said that the U.K. Opportunities Fund fell 19.3% during the fourth quarter of 2018, compared to the FTSE All-Share index's 10.3% fall, noting that the impact on performance will be felt over a five-year period until 2022. Mr. Webb said Rathbone's board decided the U.K. Opportunities Fund annual management fee should be kept at 45 basis points until performance is back on track. The firm relaunched the Rathbone Recovery Fund as U.K. Opportunities Fund and reduced its fee to 45 basis points from 75 basis points in 2017.

Other sources said managers will be focusing on aspects other than performance of the FCA's value assessment criteria.

For example, Columbia Threadneedle Investments stopped charging performance fees on Jan. 1, 2020, for a number of its funds, including Threadneedle U.K. Absolute Alpha Fund, Threadneedle U.K. Extended Alpha Fund and Threadneedle (Lux) American Extended Alpha."We have decided to stop charging performance fees on the funds as part of our commitment to ensure that our fees are fair, simple and transparent," the firm said on its website.

After May 7, Columbia Threadneedle will also reduce annual management fees on a mix of five other equity and bond funds due to "commitment to giving the unitholders value for money over the long term," its website said.

For Mike Zelouf, director of European and Middle East business at Western Asset Management Co. LLC in London, the FCA's requirements should also force active management firms to review the practice of passing costs onto investors from third-party firms such as custodians or auditors. Some firms levy non-management fees as part of total fund charges that investors pay as a percentage of fund's value as opposed to a nominal charge, he said.

Sources said that overall, firms may struggle to fully disclose to would-be investors what rates are paid by existing clients, without being concerned about their future profitability.

Noting an ongoing discussion among U.K. managers about the degree of fee disclosure, Ingrid Holmes, head of public policy and advocacy at the international business of Federated Hermes Inc. in London, said in a telephone interview money managers may initially set lower fees when launching a new fund to attract assets.

"When you are launching a new strategy, it can be at a loss," she said by way of example.