Why the IMA are so wrong about fund research.

daniel godfry

 

There had been signs that the Investment Management Association (IMA) was at last coming to terms with the needs of consumers and those who advise them to reveal the cost of owning their funds.

In May , Daniel Godfrey- its chief executive, promised full disclosure of costs and charges and the publication of the portfolio turnover rate of each fund managed. This summarised  IMA research published earlier in the year. You can read this blog here .

But recidivism has kicked in and in the three months between this “blog” and now, the new dawn has faded. This week saw the publication of another blog from Daniel Godfrey, explaining why the IMA weren’t minded to embrace European proposals which would require fund managers to unbundle the purchase of research on markets and stock from the price paid for buying and selling the stocks.

I don’t get it

As a layman, my first question is what investment research has got to do with the physical practice of trading in the first place. The answer, according to those like Mark Lawrence , COO of Fundsmith is that purchasing research this way makes life very easy for fund managers.

Assuming the research is valuable in itself, it can be used to boost the performance of the funds and is therefore seen as a legitimate fund expense that can be charged to the member. So a fund manager can run a fund with minimal research costs to itself and minimal management charges to the consumer. The fund manager is effectively outsourcing his or her research department.

But there seem to me some problems with this.

Firstly, the research is unlikely to be independent. The firms who provide these bundled services are “integrated”, they are typically banks who do everything from advising on M&A, flotations and the sale and purchase of stocks.

Case study

Let’s suppose they are advising on the flotation of a private company that wants to come to the stock market to raise capital, the adviser can give a nudge to those writing the research paper to recommend the fund picks up some of the stock that will be in offer. This keeps the client happy- he has his capital and the share price moves in the right direction. This keeps the adviser happy, his strategy is proved to have added value and he can trouser some healthy fees and it keeps the traders happy as they can offload stock that might otherwise have stuck with the bank (the underwriters of the issue) – as well as generating some commissions on the trade itself.

But is the fund manager there to keep all these people happy? He is not- his job is to keep the owners of his fund happy and it is a basic law of economics that if those on the sell side are laughing, those on the buy -side won’t!

The conflicts of interests created by buying recommendation on what to buy from the people selling you the stuff are obvious to any layman.]

But they are not obvious to the IMA, at least, Daniel Godfrey states in his blog

“Research associated with the use of dealing commissions is not an inducement.  Rather, it raises conflicts of interest, which need to be managed.”

Just how a fund manager is supposed to identify what the conflicts of interest are is not clear. If he gets a note to buy a stock that his dealer needs to sell the note is not going to read.

“Please buy this stock old chap or we’ll be left with it on our books and I and my mates won’t be seeing a bonus this Christmas”.

Untangling the genuine buy/sell note from that sales Spiegel may be a skill that fund managers can boast of (managing conflicts), but why should the manager be devoting his time to second guessing? Why should he not be researching the stock himself?

And then there’s the question of “inducements”.  Everything in this blog so far is based on the research purchased being read and acted upon. But the information I get from fund managers suggests that most of it is treated as junk and ends up in the shredder or the spam box.

If this is the case, why should a fund manager be wasting the money of those who own the funds buying junk?

It may be just a matter of laziness, poor processes, incompetence.

Or it may be that inducements are at work.

Buy my research, charge it to your clients, chuck it in the bin and enjoy the Wimbledon tickets.

Daniel Godfrey may state categorically that “Research associated with the use of dealing commissions is not an inducement” but we only have his word for it. I live , work, eat and drink in the City of London and I know exactly what is said , thought and done by those with the power of these huge chunks of money.

Some manage the conflicts and some don’t, some take inducements, some don’t.

The point is that we as consumers have no protection against bad practice other than voluntary codes put in place by the IMA and the fund managers themselves. And while the IMA are good at producing research papers and blogs that tell us what they intend to do, the fact of the matter is that consumers are still totally in the dark as to what is really going on.

Each month a new scandal is unturned, State Street stealing pensioners money from the Sainsburys Pension Fund, Barclays running dark pools with infra-red glasses, the rigged Libor-market, the mis-selling of swaps to small businesses, PPI!

What possible reason is there for us to trust the banks , fund managers and the IMA to manage the conflicts?

When the boxes at the O2, the Emirates, Twickenham and Wimbledon are packed with managers and brokers, why do we accept that inducements aren’t taken?

Thankfully, this matter will not be decided by the IMA, the fund managers and the banks but by Regulators. The FCA are on the case as are the DWP, they are not in the pockets of the fund managers like the supine NAPF who depend on the fund managers to fund their conferences and junkets. They are answerable only to Government and to the electorate, the consumers who pay the fund manager fees and the costs of the trading and research.

 

This blog was first published on http://www.pensionplaypen.com/

 

About henry tapper

Founder of the Pension PlayPen, Director of First Actuarial, partner of Stella, father of Olly . I am the Pension Plowman
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One Response to Why the IMA are so wrong about fund research.

  1. martin says:

    There are two points here:
    1. Is stock broker research wholly independent; and
    2. Is it right to charge research costs as a fund management expense.

    The issue of independence has been around for a long time. If a broker writes a Sell note on a client they know it will be “goodbye client”. Statistics which show the skew in Buy vs Sell note clearly demonstrate this bias. The best fund managers might read research reports to get information but will recognise the inherent distortion and adjust their thinking accordingly. Alternatively they might prefer to purchase research from a more independent source. All well and good.

    The trouble is they will start to think, “previously we got the research for free but bundled up with the dealing commission which the fund investors paid. So now we unbundle, the fund investors should continue to pay”, and therefore on top of the management charge. This is where things go wrong. The basic management charge should cover all the costs of research and investment decision making whether an internal cost of the fund manager or out-sourced. The best managers do their research in house anyway. A simple test would be to ask investors where they think this charge sits already and their expectation will be obvious.

    The recent unbundling of the management charge from kickbacks and hidden commissions (aka trail commission) shows that we are making progress in this area, but clearly there is more to do.

    Like

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