Poor execution – a pigsty – not a playpen

henry tapper

13 years ago

A researcher I was speaking to yesterday asked whether I considered the bad practices associated with the poor execution of trades by fund managers as criminal fraud. His argument was that indirect benefits such as the receiving of rugby tickets from your dealer went beyond “a conflict of interest” and represented “white collar theft”.

Thinking about it, I can’t call this theft, nor the activity criminal, but it is morally atrocious as those who manage funds have a fiduciary obligation to “treat customers fairly” and a legal obligation to apply best execution to their trading. The FSA’s paper on conflicts of interests should make the ranks of managers and consultants at the Home Internationals, keep their heads low as the cameras pan across them.

But we need to go beyond the banner headlines and investigate exactly what goes on when a large fund makes a trade. Where is the leakage and how can the plumbing be improved. If we know the questions to ask and understand the difference between good and bad, we can apply governance. If we don’t bother with the detail, we won’t stop the drip drip that compounds into the 40% loss of income in retirement that charges can create ;- the power of compound drippage eh!

Here are seven things that we should be looking to change to improve things

We need to improve the information flow; share and unit holders in funds get shortened reports that provide inadequate information to fully understand what is going on. The argument is that the long forms are too unwieldy and too expensive to send out by post. Get real, post is not the way to deliver this information. The default delivery option must be e-mail, the document(s) should be sent as PDFs and everyone should have both the short and long forms.
The spectacular own goal of taking Portfolio Turnover Percentages out of compulsory fund reporting needs to be reversed. The churn rate of the portfolio is a key indicator of conviction (low churn, high conviction); as importantly , it is an indicator of the costs being incurred by the fund, the more churning, the higher the costs.
We must rationalise the supply chain of information. Fund managers give instructions to dealers who place orders in the market, the costs are reported by the manager and then lost by the insurer wrapping the fund. By the time the member of a DC fund tries to access information via the platform they use, the source of the information is so distant that even experts don’t know where to go. The way to go on this, is the way the ABI have promised to go. ABI, I continue to watch for signs of progress and will admit no recidivism! We need the insurers to get the information from the IMA (it is published deep in the fund accounts). If the structures of the insured funds are too complex to report on, those structures need to be rationalised
We need to understand the market into which traders place orders. My understanding is that their are primary markets (the recognised exchanges) intermediate markets and what are referred to as “dark pools”. BEST EXECUTION involves the skilful trading across all markets , to ensure best dealing prices, lowest spreads and to minimised the pricing impact of a trade. Pricing impact is particularly important, skilful execution ensures that market makers do not see your money coming, If a market maker gets a whiff that there is a trade on the way, he has the opportunity to reprice the asset on sale to creat value for himself and take value from the fund.
Stock lending is similarly murky. The recent law-suit against Black Rock in the States revolves around that manager retaining 40% of the profits in the States and 60% of the profits from lending on “overseas” equities. The charge is profiteering at the expense of fundholders. We don’t know enough about how managers offering funds in the UK use stock lending and share the revenues (and we should).
We have to have targets for best execution, sure these will vary according to size of fund and the fund’s investment principles. The difference between “good” and “bad” on commissions is huge 3.5bps v 25bps (according to my man on the inside). Spreads are similarly elastic and while we cannot do much about the rate of stamp duty , we can minimise its impact by minimising trading. We need to know who is benefiting from stock lending and by how much.
Last but not least, we need to encourage fund managers to own the performance of their funds. There are two many jobbing managers who flit from fund to fund. The best way to reward fund managers is to get them to focus on long-term investment and this means incentivising them to think long-term. It’s good to see that Lord Turner’s parting shot as he leaves the FSA is to call for managers to be rewarded on their comittment to long-term investment.

There is no excuse for poor execution. Managers who execute well should get the money and those who don’t should be starved of funds, that’s how a good market operates. But without perfect information we will have an imperfect market.

It is up to consultants to fight this fight – there are some good consultants doing this in the UK , but not many – we need better awareness among the experts, we need consultants to be unconflicted (hats off to Towers Watson who are now not taking any incentives – even when under £10), we need consultants who are going to be tough on this.

We need trustees who are going to learn from consultants and make independent researches. On this subject , they should spend time exploring Alan and Gina Miller’s excellent website http://www.trueandfaircampaign.com/.

We need journalists , commentators and bloggers to keep up the pressure.

Finally we need regulators to continue to apply pressure on the ABI and more particularly on the IMA. These trade associations rightly act for their members and not the consumer. But when it is recognised that the interests of manager and consumer can be, should be and will be aligned -WE WILL GET CHANGE.

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