This overconfidence affects both managers and investors: managers are too confident in their abilities to outperform and would therefore regard their product as less commoditised; investors are over-confident in their ability to pick good managers and moving from active to passive would mean admitting they were wrong.
Paul Craven, founder of Behavioural Economics, says: “I have worked with plenty of very skilful investors in my time, at three great firms, but at an overall industry level meaningful outperformance of benchmarks, over the medium/long term and after costs, is a lot less prevalent than is acknowledged by many active investors.”
Faith in active management is not dissimilar to Oscar Wilde’s description of second marriages as “the triumph of hope over experience”, Craven says. Rather than transparency, the best antidote to behavioural biases is genuine diversity, something many trustee boards, for example, lack.
RACK RATES VS. ACTUAL RATES
However, the picture painted by the FCA report is arguably worse than many investors experience. The FCA’s analysis was conducted based on the ‘rack rate’ or headline fee rate for a fund, which for active management was 1% on average.
But, in practice few institutional clients pay that rate.
Tim Giles, senior partner at Aon Hewitt, says: “The fees for some of the best asset managers are well below the rack rates – roughly 25% to 50% less.”
So, while active managers might say they do not compete on price, clearly there are big discounts to be had for the right investors. Discounts on that scale would also meaningfully adjust the percentage of managers able to outperform in favour of active managers. It could also mean the difference between value or not.
“A 25% discount, for example, can change things quite meaningfully and could move a manager from amber to green when it comes to assessing value for money,” says Redington’s Gardner. As one of the main factors affecting the price an investor actually pays is the scale of assets they have to invest, consolidation among investors would also help deliver better value for money to investors.
PROFIT MARGINS
Scale doesn’t only help the investor though. It also provides economies of scale to the asset management firm. To date, however, firms have not been passing those benefits on to their clients and have instead retained the savings resulting from economies of scale for themselves – another sign that competition is failing.
Many investors have called for fund fees to come down as assets under management increase, but so far this has fallen on deaf ears among asset managers. The lack of competitive forces in the industry has allowed them to maintain their profit margins at 36% over time (although the FCA’s report points out that these margins are even higher if the profit-sharing element of staff remuneration is included).
Interestingly, this profit margin is the same for passive as it is for active management firms and suggests fees in both sectors still have considerable room for movement. According to Aon’s Giles, asset management margins are generally too high.
“If managers are reliably getting high returns, they can more easily justify those margins,” he says. “However, we should see that margin as a whole come down. Transparency is a part of that process.”
Transparency is clearly a key cog in the mechanisms that will help improve the competitive environment for fund managers. That, in turn, should deliver better value for investors by reducing headline prices and ensuring more of the benefits of economies of scale are equitably shared.
However, cost transparency is not a panacea. With it must come more standardisation, better board diversity and greater consolidation among investors.
Pan Trustees’ Mattingly concludes: “The FCA’s findings were pretty hard hitting and present a significant challenge to the asset management and advisory community to prove that they are adding value.
“It is right the FCA came out with these very thought provoking comments,” he continues. “There has been complacency in the industry. This has reduced, but it still exists, which is unacceptable. There is no doubt that active managers and advisers will have to give evidence that they are adding value.”
