Fees and costs currently present themselves as the top controversial issues within the investment industry. The key challenges on this topic, bearing MiFID II in mind, were discussed by Aisha Dudhia (JWG Group), Steven Charlton (Vanguard Asset Management) and Bart Heenk (Avida International) at Professional Investor’s latest roundtable.
1. Is there enough transparency in asset management fees and costs?
Concerns regarding transparency within this sector are nothing new. Regulators, predominantly those in the UK, have been calling for greater transparency in asset management fees and costs for over a decade. Years of partial reforms, amounting only to incremental improvements to the existing rules, have forced supervisors to call for wider reforms.
Reviews of the current regime have highlighted two persistent problems in terms of transparency for costs. Firstly, services are being ‘bundled’ together, with eligible and non-eligible services being mixed. Secondly, there is a lack of clarity around how transaction costs, including commissions, have been spent. Considering that transaction costs, alone, can add another 50 to 85 per cent to overall fees, investors need to be aware of this expense.
Although the industry has been under mounting pressure to provide greater transparency over fees, the charging structures of some are still far from clear. Under current regulations, fee structures are primarily a percentage of the assets under management and are not necessarily linked to costs incurred. Consequently, when fees are not transparent, nor linked to the costs incurred, clients may wonder whether they are getting value for money.
2. How is regulation, like MiFID, changing this?
Big changes are coming to the fund management industry. In the UK, the Financial Conduct Authority has been looking into various issues, such as how research is paid for, whilst the Investment Management Association has called for changes to be made to the way information is presented to clients. Plus, big pieces of EU legislation, such as MiFID II, will also have a significant impact on asset managers within the EEA.
The MiFID II rules apply to financial intermediaries and call for all costs, ranging from ongoing charges to research fees and detailed transaction costs, relating to investment or ancillary services and financial instruments, to be disclosed to investors. These new regulations encompass a wider range of costs than those previously required under MiFID I, and the costs and charges are required to be presented as an overview, with the possibility of a request for an itemised breakdown.
MiFID II requirements do not currently apply to UCITS funds, as greater cost disclosure for these products has only been scheduled for the end of 2019, via the European Union’s Packaged Retail and Insurance-based Investment Products (PRIIPs) regulation. Nonetheless, as discretionary and advisory portfolios are captured by MiFID II regulations, UCITS providers will effectively have to give more detailed information on costs in order to allow intermediaries to comply with the rules.
3. How do you define or measure ‘value for money’?
It is hoped that MiFID II will encourage a focus on quality and ‘value for money’ within this market. This should result in more effective competition which will be in the interests of consumers. Still, one technicality that has arisen in light of these new regulations is the difficulty in valuing these goods and services.
‘Value for money’ aids in assessing whether or not a firm has delivered the maximum benefit from the goods and services it has provided, in relation to the resources available to it. Although the term measures both the cost and benefit of the services, it also takes into account a mix of quality, resource use, fitness for purpose and time associated. These factors can be used to judge whether or not the services constitute good value and, together, can help in providing a specific price.
The bottom line is that, as some elements are subjective, difficult to measure, intangible and misunderstood, market participants will struggle to price their goods and services. Furthermore, the receivers will have to judge whether these goods and services hold the correct value for money, necessitating the creation of pricing mechanisms and billing systems.
4. Costs are mounting for investment firms. Where are those costs coming from, and are they having an impact on business models?
When considering the breakdown of the overall cost burden that MiFID II will have on investment firms, the impact of increasing transparency in asset management fees and costs, although significant, is not that onerous in comparison to other aspects.
Asset management firms are currently incurring large compliance costs, due to the need to focus more on efficiency and transparency under MiFID II. In particular, the majority of firms are looking to set up centralised regulatory functions to ensure compliance with the new rules.
IT infrastructures within asset management firms will also require updating. New regulations bring the need for pricing mechanisms and billing systems, as well as asking for ways of publishing information in an easy to understand and consistent format for clients.
Additionally, operating costs are expected to rise and, according to PWC, are currently increasing in preparation for MiFID II. In order to deal with cost disclosures and the monitoring of harmonisation of costs, firms have been hiring more employees and investing in new technology.
5. What more can be done to align fees between investors and managers?
The misalignment of fees between investors and managers is commonly referred to as the ‘principal-agent problem’, where, although a principal uses an agent to achieve a goal, the agent may be motivated to act in his own best interests.
Fees and co-investment tend to be viewed as the key elements considered when endeavouring to align the interests of asset managers and investors. Generally, if the elements are combined, using an appropriate mix, then interests are also likely to be aligned. Finding the right mix, however, is difficult.
Although asset managers do tend to charge annual management fees, many investors are less willing to invest in a fund where the manager collects performance fees. Advocates of performance fees tend to argue that this motivates managers to generate a higher return. But there are drawbacks, such as a lack of clawback clauses, when using this method alone.
Co-investment is the stronger element, when attempting to align interests. Having a significant amount of capital invested along with the principal tends to boost incentives and can improve decision making. Co-investment appears to work best when the manager and the investor have the same goals on time horizon, risk tolerance and fees. When these goals differ, this tends to lower any positive impact that co-investment has on the alignment of interests.
6. Are fee caps good for the industry or do they lead to unintended consequences?
Implementing fee caps within an industry where there is a clear lack of transparency is likely to result in unintended consequences. In fact, previous attempts to improve disclosure and cap fees have failed due to “stiff and effective industry resistance”.
Firms wishing to act in the best interest of their investors may wish to introduce caps, as fees tend to erode returns for their clients. Yet, various obstacles across the industry may prevent the successful application of fee caps. In particular, the industry would have to decide at what percentage to cap the total fees to provide a better return for investors and must determine what costs, for example, transaction costs and distribution charges, would be covered by the cap.
Overall, under the current regulations, where total investment costs are not ultimately disclosed in full, implementing effective and meaningful caps on fees would be challenging. Questions surrounding how investment managers would then assess their true value added would arise. Once the new regulations are in place and, if greater transparency is achieved, the industry will be in a better position to assess the impact of fee caps.