What does it really cost to run a fund? (Long read)
By Stephen Little
Fund managers are being urged to give a clearer breakdown of the actual costs they incur and how they spend their time, amid increasing pressure to prove value for money.
There are a whole host of costs involved in running a fund, from research and trading fees, to set-up costs and the wages of support staff, not to mention office space, marketing, business development and, of course, what you pay the fund managers themselves. But is there upward pressure on these elements to justify investor fees?
The cost of diving deep
Royal London Asset Management head of sustainable investment Michael Fox says that while the job description of a fund manager has changed little in 20 years, the amount of information they are bombarded with on a daily basis has soared.
This means the time and cost of wading through in-depth research is now significant, particularly for those investing for the long term.
Fox says: “The average person probably thinks fund managers spend their day watching what’s happening on Wall Street, looking at screens and screaming down the telephone – this couldn’t be further from the truth.
“In reality it is a cerebral, research-based occupation. We focus on reading and understanding the short-, medium- and long-term drivers of stock markets and companies, and more broadly that’s where we find our differentiating investment ideas.
“It’s not an intelligence quotient game, it’s a temperament game. You have to be able to keep calm and exhibit a certain temperament with the day-to-day market movements.”
Kames head of wholesale business Steve Kenny adds that the need to target the right product to the right markets – now enshrined in the Mifid II regulations – has become harder and put upward pressure on fees.
Kenny says: “The costs of doing business have increased significantly over the past five years. It is becoming more expensive to deliver a fund and oversee that it goes to the right audience and the right channels.”
He also notes an increased regulatory burden more generally and the growing requirement to disclose information to clients in a digestible format. While this has changed how fund managers spend money on getting their message out, it may not have decreased the cost of doing so.
Kenny says: “Advertising has evolved from paper to online, so the way we spend our marketing budget is different to a few years ago.”
"The time and cost of wading through in-depth research is now significant"
Since 3 January, Mifid II requires investment managers to disclose extra transaction costs charged to their funds, separately from the ongoing charges figure.
The directive also requires financial advisers to report all the costs back to their clients.
As a result of the new rules, clients may not be paying any additional charges, but they can now see separately how much the transaction costs have always added to the total.
In response, the majority of fund managers have now absorbed the costs of the new regulation, which has hit their bottom line. Kenny says this is because research and transaction costs could have accounted for a significant portion of the costs incurred in running the fund.
He adds the introduction of Mifid II has led to an increase in costs across the board.
He says: “Mifid has brought with it the cost of research, which is an explicit direct hit, but there is also the ongoing increased regulatory burden as well. There is the requirement that we oversee our key distributors and that requires people to do that and systems to record that, so there is a whole raft of governance. This type of work can’t be done by administrators, so there’s been rapid growth in the accounting, compliance and legal departments.”
The manager’s take
The FCA has been accused of failing to address fund manager pay in its asset management study. Despite accounting for the largest proportion of the costs of running a fund according to many analysts, critics argue more detailed disclosures about fund manager pay are necessary.
Kenny says the cost burden of managers has now been spread out over a longer time period by firms, rather than in peaks and troughs that could surprise investors.
He says: “The days of getting huge cheques each year have been modified with an allocation for pay spread over three and five years. This means it’s difficult, if you are a successful fund manager, to move from business to business as you would be walking out on a significant portion of your paying rations.”
The FCA has previously warned in its asset management market study that price competition is not working as effectively as it could be. Fund management companies must now illustrate how they provide value to investors and that their charges are reasonable in relation to costs.
Adviser view: Keith Churchouse, director, Chapters Financial
I don’t think I have seen many costs come down, or at least not people advertising to say: “Here is exactly where we have managed to cut our costs.” That ends up almost being bad PR; it demonstrates there were excess charges before and some people would argue you should have done it earlier.
I haven’t seen any particular changes since Mifid II. The marketing pushes may have gone down slightly, but recently a pile of glossy brochures was dropped on my doorstep by an individual sales rep clearly still treading the streets of Guildford. Post-Mifid II you thought that would have changed, but here we are seven months later and in reality it hasn’t at all. The marketing staff and printing costs are still there. All the costs in a fund have been laid bare, but not reduced.
After receiving feedback to its consultation, fund managers will still have to produce an annual value statement, but this will not be described in “value for money” terms after industry representatives criticised the wording for being too focused on charges and not on the wider benefits of the product.
Finalytiq director Abraham Okusanya says fund fee levels are too high and are “definitely not justified”.
He says: “I just want to know how much it costs me to hold the funds. Mifid II is supposed to deal with that. The OCF gives us some idea of what the manager is charging for their service. It’s all the other things we don’t know that may or may not be included in the OCF that’s causing problems. The rule around the disclosure of transaction fees is confusing for advisers, let alone investors.
“There are arguments that the asset management industry and the service itself does not succumb to price pressure like other industries, so I would make the argument cautiously about market forces sorting this out.”
In its asset management study, the FCA found average profit margins of 36 per cent for the firms it sampled.
EY senior adviser Malcolm Kerr says that in some cases the fee costs are justified if the manager is providing alpha. He says: “If a fund is not creating much alpha or doing better than a passive fund, then you could say the value is questionable.
“Most asset managers recognise that regulation and consumer pressure are going to make it challenging to achieve the same margins that they did in the past and the move towards trackers will exacerbate that.”
The FCA revealed earlier this year that asset managers have paid back £34m in compensation to investors who were overcharged while using closet tracker funds. It came after an investigation by the regulator that found that funds purporting to be actively managed were in fact buying a basket of shares that closely tracked an index.
While the FCA is starting to crack down on closet trackers, Okusanya believes the regulator needs to do more. He says: “The FCA’s approach doesn’t go far enough, especially in areas such as closet indexing where managers are promising that they are going to beat the market, but are essentially just following the market.
“It is misrepresentation of the service. The regulator’s going to see if soft regulation works and if that doesn’t it will try something else. To my mind it needs to do more.”
Building blocks of costs will soon come into the open
While asset managers are cagey about the costs of running their funds, Mifid II has started a move towards greater transparency and overall costs to the end client. This applies particularly to things like transaction fees, where previously certain parts of the industry were denying their existence. Those figures are now being disclosed.
Fast forward to September next year, when the value test will require asset managers to be more transparent around that. They will also have to document how they are focusing on reducing the costs wherever possible, particularly where there is a specific question on economies of scale and whether the customer is benefiting. The wider question is whether the returns justify the level of fees charged.
The overwhelming conclusion from the FCA is that fund managers are not providing value for money. In particular, there was not enough focus on driving down those costs.
Fund groups are transparent about costs post-Mifid, but being in a market where consumers don’t understand this stuff can allow people to hide things in plain sight.
The next wave is the requirement for annual statements to be sent out, confirming the actual charges you have paid in the past 12 months.
The requirements that the FCA is pushing on to asset managers reflect the fact that the general public simply does not understand or engage with this issue, so the asset managers need to take on more responsibility that their products are value for money.
The bulletin the FCA put out about the Senior Managers and Certification Regime confirms that this value test is going to sit under that regime. It is a prescriptive requirement for asset managers to identify and appoint an individual who will be effectively liable.
Mike Barrett is consulting director at the Lang Cat