Cass calls on fund managers to be paid on results.




Dr Nick Motson of Cass Business School has issued another broadside at the funds industry who have been dilatory at best in responding to consumer pressure to better align its fees to the value it brings to consumers.

Cass’ idea is a simple one, fund managers would be paid on performance against what they said they would do. A sophisticated version of “no-win, no-fee”. The argument is that the good ones would be paid more and the poor ones less. The poor ones would have to leave the market- to everyone’s relief.



But it’s not as simple as that is it Justin?

Listening to Radio 5 live, I heard my red braced school-chum Justin Urquhart-Stewart defending the fund industry’s practice of charging people a % of funds under management rather than linking fees to the performance or underperformance of the fund – relative to what that fund set out to do – e.g. the benchmark.

This is of course, entirely missing the point – deliberately some would say!

Fund managers can (and should) be paid performance fees even if the fund shrinks!

The example was given of a fund manager investing in Japan who would have seen his fees fall over 20 years because of the capital losses in the Japanese Stock market. As I understand it, an active fund manager who had seen a fund fall by less than the benchmark (typically a Nikkei index) – would get paid more than a passive manager who just delivered the market return. The example is again irrelevant.

The point of aligning fees to performance against the stated aim of the fund is that it does not reward the 80% of active managers who consistently fail to bring home the bacon and bring some risk to the business of active fund management – to the managers!

But active managers should not be rewarded for not doing what they said they would

At present, anyone can set up as an active manager and charge high fees (1.5% of the fund is typically quoted as the RRP). But so long as the fund continues to benefit from the support of its uni-holders, the manager continues to rake it in whether he or she does well or badly.

Which makes for an appalling lack of incentive on the manager to perform. It makes for lazy behaviour (see the stuff below on charges) and it makes for a culture where the creature comforts of managers come before the returns of the investors

On the radio, the question was asked –

“why do investors stick with active fund management”.

The answer may lie in the difficulty of moving money, it may lie in the expense of moving money and it may be because investors are trying to buy and hold- as Warren Buffett tells them to.

Whatever the exact reason, investors are doing for fund managers, what fund managers need and want, giving them the long-term horizon to buy and hold for value. The question we should be asking active  managers is why they are doing so little to reward the people who are being loyal to them.

One thing that is for sure, is that all the cards are in the active managers hands and we can see (below) that the active managers are not too keen to show their hand to people who ultimately own the money.

This is known as fund management’s “asymmetry of information”.

Justin blithely spoke on Wake up to Money this morning about the days when fund managers were obliged to churn their portfolios every year to generate extra commission for the managers. Apparently these days are gone. This was another (successful) ruse of Justin to throw the pursuing journalist off the scent.

For, within the past two years, research by Dr Chris Spiers, the new MD of KAS Bank, showed some active fund management houses were still churning portfolios to a point that it was nigh on impossible to justify the transaction costs involved by the potential for higher performance.

Not only was Spiers’ research suppressed, but the fund management industry, led by the Investment Management Association, continue to suppress information on the portfolio turnover rates  (churn rates) of active funds.

Performance fees and full cost disclosure go hand in hand

The issues of linking active performance to fund management charges and the disclosure of the true costs of investing are co-joined. Many active managers have such high transaction costs (resulting from poor execution and over-trading) that they become serial underperformers no matter what the skill of the managers. It’s like trying to win a horse race with Fatty Arbuckle on its back!

For the fund management industry to own op to the true costs of active management, it would have to expose itself to the criticism of the journalists on Wake up to Money that allowed Justin to kick the issue into the long-grass.

There would be nowhere for fund managers to hide.


Earlier this year, the Pensions Institute issued a report that claimed investor returns are being hurt by hidden costs that are at least as big as the visible costs in actively managed funds. Here is the meat in their sandwich

Asset managers should be required to reveal the full costs of active fund management to help investors see the full drag on their returns.

The Pensions Institute at Cass Business School has published a white paper calling for asset managers to disclose all visible and hidden costs which are ultimately borne by investors.

Research cited in the paper suggests that concealed costs – such as bid-ask spreads and transaction costs in underlying funds – can make up to 85 per cent of a fund’s total transaction costs. The remainder is taken up by visible costs such as commissions, taxes and fees.

Director of the Pension’s Institute, Professor David Blake, said: “No good reasons have been put forward for why all the costs of investment management should not be fully disclosed. They are after all genuine costs borne by the investors.

“There is little point in requiring transparency where the reported measure for ‘costs’ does not include all of the costs, or in the short-term, as many costs as could currently be reported on an efficient basis.

“If total investment costs are not ultimately disclosed in full, how can there ever be an effective and meaningful cap on charges, and how can active investment managers ever asses their true value added?”

Costs could be reported in the form of a ‘rate of cost’ – which could be deducted from the gross rate of return to give a net rate of return – and as a monetary amount, which could be compared with the monetary value of the investor’s portfolio.

The paper suggests a staggered approach could be taken in the lead up to the full disclosure of all transaction costs.

In the initial stage, investment managers should be required to report all visible cash costs involving commissions, taxes, fees, custodial charges and acquisitions costs, together with the hidden cash costs of bid ask spreads, transaction costs underlying funds and undisclosed revenue.

“All these indirect costs relate to the efficiency of the investment management process and all good investment managers should have an estimate of their size,” said Professor Blake.

Once investment management firms have the right IT systems in place, non-cash costs should also be reported comprising of market impact, information leakage, market exposure, market timing costs and delay costs (see below).

Professor Blake added: “The hidden non-cash costs would be more challenging to calculate, since they involve the analysis of information that might not necessarily be automatically captured by the investment manager’s own systems. Nevertheless, the issue is whether fund manager systems could be configured to generate similar information on a cost-effective basis.”

Visible cash costs

  •   Commissions
  •   Taxes
  •   Fees
  •   Custodial charges
  •   Acquisition costs

    Hidden cash costs

  •   Bid-ask spread – of the hidden costs, the simplest to understand is the bid-ask spread that a dealer or market maker charges to buy and sell a security or an investment bank charges for, say, a currency hedge. The total spread costs incurred during the year will be related to the annual portfolio turnover.
  •   Transactions costs in underlying funds – if the investment manager buys funds on behalf of the investor, the transaction costs incurred by these funds are not reported even to investment managers, but are still paid by the investor in terms of a lower return.
  •   Undisclosed revenue – the investment manager might also benefit from undisclosed revenue, such as retained interest on underlying cash balances or retained profits from stock lending.

    Hidden non-cash costs

  •   Market impact – refers to the reaction of the market price to a large transaction, such as a block sale of securities. The market price will fall in the process of selling the securities and the average execution price will be below the pre-sale price. If the investment manager attempts to execute a large transaction in smaller batches – e.g., by advertising trades to attract buyers or seeking indicators of interest – this will lead to information leakage and will have broadly the same effect as market impact.
  •   Market exposure – refers to the fact that an investor is exposed to what is happening in the market during the period that the transaction is taking place. Suppose the investment manager is planning to buy securities for a client. The client is exposed to the risk that the market price rises before the transaction is executed.
  •   Missed trade opportunity or market timing costs are the costs associated with not executing a transaction at the best possible price. Finally, there are delay costs associated with waiting for transactions to complete (e.g., holding the purchase price in a zero-interest account). Some of these non-cash costs can be hedged against – e.g., those relating to adverse market movements – but the cost of the hedge then becomes an explicit measure of the hidden cost.

    Memorandum item:

On 13 May 2014, the Financial Conduct Authority criticised the investment management industry for not reporting charges to investors sufficiently clearly. In particular, it criticised the annual management charge (AMC) as failing ‘to provide investors with a clear, combined figure for charges’. Instead, it recommended the use of an ongoing charges figure (OCF) which, in addition to the investment manager’s fee, includes recurrent operational costs, such as keeping a register of investors, calculating the value of the fund’s units or shares, and asset custody costs. In other words, the OFC measures costs that an investment manager would pay in the absence of any purchases or sales of assets and if asset markets remained static during the year. The next day, on 14 May, the Financial Reporting Council accepted the Investment Management Association’s (IMA) proposal to report not only the OFC, but also all the dealing costs and stamp duty paid when an investment manager buys

and sells assets in the fund’s portfolio. IMA chief executive Daniel Godfrey said: “Our new measure is simple, easy-to-understand and covers every penny spent by a fund…It will give investors confidence that nothing has been hidden.” Unfortunately, even with the new information reported, there will remain costs that are hidden.

Fortunately, the FCA are on the case, they will not be fobbed off by stockbrokers in red-braces- no matter how charming!

The days of active fund managers getting away with lazy practice and in extreme cases malpractice, have to come to an end. Full disclosure of funds will be necessary for the IGCs from next year, and if the information is in the hands of the insurance platform managers, it has to be put in the hands of those who run institutional pension funds and individual portfolios of funds- soon after.

When the public sees the cost of active fund management, fund by fund, they will be able to decide which active fund managers are really doing their job on the hard evidence of cost control and performance against the stated ambition of the fund.

This will be a better basis than the current practice which appears to be based on the publication of ever more extravagant advertisements professing the prowess of fund managers and based on little more than pretty pictures.

And so say all of us , at….

hi res playpen


About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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1 Response to Cass calls on fund managers to be paid on results.

  1. George Kirrin says:

    The CASS research paper, Heads We Win Tails You Lose, is still not available, presumably not until after this Wednesday morning’s launch.

    I’d prefer to read the whole paper before reacting in detail to self-promotional interviews. My sense is that until investors stop expecting to beat the market, or at least matching the market, and articulate instead what it is they need, things will still be slow to change.

    In my own case, I need income but I also need capital protection (from permanent losses) with some growth over time. It’s not impossible to design investment mandates which address these needs and to share rewards accordingly, but the vast majority of mandates still seem to me to be designed to deliver market relative returns.

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