I have been spending some time making a submission to the FCA about the CP16/30 transaction cost paper. While doing so- I re-read the Executive Summary of the Asset Management Study, which followed a few weeks later.
It would be very arrogant of me, having made so much fuss about the need for change not to respond to these consultations. Change may be close but it not a certainty and if you feel strongly about things, you have a moral duty to respond.
I have responded to CP16/30 which is a relatively easy thing to do. We need a system to analyse what we are paying for funds and the system the FCA has arrived upon (calculating “slippage”) is pragmatic and will be effective. With that system in place , trustees and IGCs can calculate value for money and – make sure we get it. If they cannot do this, we will need to incorporate the hidden costs into a charge cap and legislate. All this is mechanistic, nothing needs be done other than to see what happens and react.
What is a lot more difficult is to get to grips with the cultural problems that are identified in the FCAs Asset Management Study. The study identifies a fundamental breakdown in the breach of fiduciary law, which underpins most of the law of the land. The assumption we behave decently to each other is the basis of trust and “trust law”, but the 208 pages of the study show again and again that those who manage the money, have little interest in the beneficial owners of the money. The FCA refer to this as “market failure” but that is to depersonalise the problem. The problem is that some of those who run out money don’t give a shit.
When re-reading the report , I was struck by this one chart which seemed to sum the economic problem up
All that glitters…
What it shows is the cost of ownership of an active fund management strategy against a passive strategy. Despite it being marked as “£”, the bottom scale is market off in basis points (1/100th of a percent). You can see the cost of owning an active fund is around 2.25% while the cost of owning a passive fund is around 0.45%. The coloured boxes show where the money goes.
We know that a difference of 1% in management costs works out at around 28% over the typical investment lifetime of an investor, so we can deduce that the active investor is going to have to make up around 50% more from active management to meet the added costs of the fees. We know from all kinds of studies that this rarely happens.
I know where it does happen but I also know who won the Hennessey Gold Cup and that those who bet on the winner trebled there money. The point is that you wouldn’t rely on winning a bet on a horse race for your retirement and you wouldn’t bet on picking an active manager to get you an extra 50% over the market return.
But of course we do! Not because we like taking risks, but because others believe they can take risks for us and we put our trust in them. The problem is not just with these expensive active funds, nor with the people who convince us they can pick good funds but with a system where the risks simply aren’t laid out in front of people in a sensible manner.
So let me make it quite clear. We (that is the body of professionals who make actuarial assumptions) do not anticipate getting real returns from the market of more than 3% over time. Real returns mean returns over and above getting your money back and the inflation on that money. If the cost of owning that real return of 3%, is 2.25%, then the net real return is only a little over inflation, which really doesn’t compensate you for the risk of something going really wrong.
Which makes active management , for all but the few who can afford the risk, a bad deal.
There is no if or but about this. Active management is simply not “on” for most of us, any more than driving around in a top of the range Mercedes or living in Knightsbridge. We simply can’t afford it.
But whether you are an IGC , or a trustee of an occupational scheme or an ordinary Jo or Joe, you will be sold active management despite it being beyond your means. You will be sold the idea that it will get you where you want to go, quicker, more smoothly and in style. You will get a platform, a portal and advice – none of which you can afford. But you will think you can afford it because the price of these services is bundled into the overall price of the product.
It’s a matter of fuel efficiency. That passive fund is drinking fuel at a very lean rate while your active fund is guzzling – satiating the thirst of “front line staff” “third parties” as well as meeting the substantial “operating costs”.
So while you sit back and enjoy the view, the petrol gauge is swinging to empty and by the time you get to where you want to go, you find you are out of gas.
It’s not the purchase price -it’s the running costs
The costs of ownership of the financial products we are being asked to purchase range from the fuel-efficient workplace pensions that can charge less than 0.5% pa to the gas guzzling platforms with multiple wrappers and model portfolios and discretionary management agreements giving us access to active management at 2.5% +
The issues the Asset Management Study addresses are the same for retail customers as they are for institutional customers. Trustees are just as capable of over-purchasing.
We over purchase because we do not know the cost of what we are buying, either in absolute terms or in terms of the loss to the outcomes of our investments.
This is no surprise, it is extremely hard to see the price tag or to ask the question “can I/we afford it?”
But we need to be able to ask and answer these questions before purchasing and we aren’t doing that – whether we are institutional or personal buyers.
Top shelf material
At the heart of the FCA’s Asset Management Study is the same question that was the focus of the OFT’s attention in 2014, how can we make people better buyers?
My suspicion is that you cannot make people better buyers, you can only make it easier for them to buy well. That means clearer instructions on how to buy, better labelling and more top-shelf products.
Quite frankly, active management brochures, like brochures for super-cars are top-shelf material! They are too tempting for our own good!