The FCA have produced some important findings on Unit Linked Fund Governance as a follow up to their Asset Management Market Study (PS18/8) – AKA – AMMS

This paper is important as it goes to the heart of the “agency” problem surrounding our defined contribution savings.

When we save into a workplace pension we rely on the pension provider (our agent ) to negotiate the best deal for us with an asset manager and present us that deal in a unit-linked insurance contract. We have no idea what the underlying deal with the asset manager is as this is typically concealed using a non-disclosure agreement. So we have to trust our workplace pension provider to get us value for our money and pass this value on to us in the price we pay for their service.

There are many ways for fund managers to be rewarded for their work; these include kick-backs from lending out the stock they manage with our money. The quote above has me question why we should be paying fund managers at all. Indeed I understand that if you have £1bn or more, you can actually be paid for investing with some fund managers.

Unfortunately, the verdict of the FCA is that the process used to get us this value is weak and that those charged with ensuring it is tightened up, aren’t really doing their job. Clearly not all pension providers are asking the questions I am asking.

This is how the FCA introduce the subject

A key finding of the AMMS was weak price competition in the sector. This was partly because retail investors do not usually negotiate with asset managers and because fund governance bodies acting on their behalf do not typically focus on value.

In response, new rules coming into effect later this year will strengthen and clarify authorised fund managers’ duty to act in the best interests of their investors. This includes requirements for an annual review of value and for increased independence. These new rules will not apply to unit-linked funds. Insurance companies are not subject to the Collective Investment Schemes sourcebook (COLL) or other Handbook rules that impose a specific requirement to apply governance standards considering value at fund level.

Unit-linked funds offer many similar features (and are of a similar size, in aggregate) to authorised funds. They are the dominant fund structure through which people save for their defined contribution pensions. So, we wanted to find out whether there are similarities between unit-linked funds’ governance practices and those for authorised funds.   I doubt that many of us know that there was an authorised fund and a unit-linked fund . To explain – the unit linked fund is a wrapper around authorised fund or funds which allows the fund to be considered as an insurance fund and so sit on insurance platforms suppling investment choices to people using personal pensions , insurance bonds and a few old legacy pension products like Retirement Annuities.

I doubt almost anybody knew that unit linked funds feel outside the new rules coming our of the AMMS and the FCA have got a job on their hands to explain to people like me (who see this as important) why the rules should not be extended to cover insurance companies offering these funds!

The need for change is obvious if you read the FCA’s findings.

Findings

How firms think about value is sometimes too limited

Some firms only consider performance net of fees and charges, with limited assessment of how active the manager of a unit-linked fund had been in achieving the net performance. Some funds’ fees were set such that it was likely they would generate outcomes similar to those of low risk products such as risk-free bank deposits, even though the funds were investing in higher risk equities and corporate bonds. A few of the firms had a more comprehensive set of criteria for assessing value. This included the quality of additional benefits and services provided with their unit-linked funds, and the frequency and clarity of their communications and other engagement with investors.

Firms often do not compare fund fees with others in their range

Firms typically do not compare the fees and charges of different funds within their unit-linked fund ranges, even where funds have similar mandates. Firms were generally unable to provide reasons for significant disparities in fees and charges among otherwise similar funds, beyond describing market pricing practices when the unit-linked products offering these funds were sold.

Firms share scale economies with funds only to a limited extent

Where firms appoint asset managers within the same corporate group to manage unit-linked funds, we often found less-extensive efforts to negotiate savings in asset management fees as the funds grew in size, relative to where firms appoint external managers. These firms were also typically less likely to address a fund’s underperformance with timely and meaningful measures, such as changing the fund’s manager.

If firms do identify scale economies and other opportunities to achieve efficiency gains, they often only pass benefits on to unit holders through reduced fees where they are contractually obliged to do so. This can lead to a firm treating groups of funds quite differently depending on how terms and conditions vary between its unit-linked funds.

Firms comply with regulatory interventions but tend not to go further

Firms have passed on the benefits of default fund workplace pension fund fee caps to unit-linked funds that are within scope of the cap. But they had typically not considered whether they should run other, similarly-managed funds in their range at the same rates to provide better value to all their customers.

Firms have typically responded to other regulatory initiatives, such as our guidance on the fair treatment of long-standing customers, by reducing fees for the most expensive funds in their range. Where firms had cut fees, we observed limited ambition in the scale of reductions which were not always calibrated in such a way as to ensure good customer outcomes. For example, we saw that some funds’ charges were reset to ensure that, at maturity, investors received at least their initial investment plus an adjustment for inflation. We saw others that were reset to achieve the same return as a risk-free bank deposit. These were funds that invest principally in equities and bonds, with commensurate levels of investment risk.

Firms were unable to show us how product features other than asset management were good value

Sometimes, funds’ asset management charges accounted for a very small percentage of the total product charges. But, even in such circumstances, we saw little evidence of substantial assessments of whether other product benefits and services offered good value.

Firms check their competitors’ prices but not apparently with the aim of competing on price

We observed firms comparing their unit-linked funds’ fees and charges with those of other firms. However, we saw that the aim appeared not to be to undercut their competitors but rather to ensure their pricing structures were within the standard ranges in the market. One firm commissioned consultants to compare its funds’ charges with those of competitors, but required the consultant to do so using assumptions that appeared to flatter the firm’s funds. The firm used the consultants’ output to suggest that its funds are good value.

Institutional customers often drive hard bargains; they may have less need of the investor protection afforded by fund governance

We saw stronger evidence of more effective demand side pressure where decisions on the selection of unit-linked products are made by institutional investors that are advised by an investment consultant (including most large pension funds). We could see that this typically led to significantly lower fees and charges than for similar unit-linked funds sold to retail investors. Institutional investors and/or their investment consultants often push firms to be competitive in the prices they charge, and are also active in assessing on-going performance (switching providers when they experience poor performance).

The impact of independent governance bodies has been positive if limited

IGCs and GAAs have a remit to oversee unit-linked fund performance but only to the extent that funds are used as investment vehicles for workplace pensions. Their oversight does not extend to other products that invest using unit-linked funds, including non-workplace pensions and investment bonds.

Some of the IGC and GAA members we met told us that they saw their role principally as checking that the firm had a reasonable process for assessing value, rather than undertaking their own value assessments. They said they had been successful in tackling ‘quick wins’, typically involving fee reductions for the most expensive workplace pensions where investors were projected to experience very poor outcomes. They’d paid less attention to other funds. A common view was that they had not been inclined to challenge fees if firms had matched fees to relevant charge caps, even where firms appeared to benefit from substantial economies of scale and other efficiency gains. IGCs were not breaking down the total fees of each unit-linked fund or product among the various component parts of the unit-linked service provision (eg asset management, administration, distribution) before assessing their value. This means that the quality and benefit to investors of each component was not being considered in the context of the additional costs investors were incurring for that component.

IGC/GAAs voiced some frustration that their annual reports are not always given sufficient prominence on firms’ websites and in investor communications. We saw at least 1 case of an annual report that was quite critical of the value for money offered by a firm. This did not appear to have affected the firm’s subsequent sales, suggesting that the report’s message had not influenced investors’ decision making.

I will be returning to these finding over the next few days as our fiduciary agents (trustees, IGCs , GAAs and the insurance companies) appear to be sometimes falling short and I’m going to be very interested in the “remedies” that the FCA propose when they do.

This is really important. Not only are unit-linked funds the very building blocks of our retirement pots, but they appear to have been left out of the regulations governing AMMS and I suspect this is giving scope for all kinds of shenanigans about which we are still to here.

In the interests of getting consumers a consistently better deal, we need the FCA to nail this. We should be supporting them in any way we can.