Too big to ignore
The United Kingdom has found the right way to crack down on the fund management sector. Asset managers earlier this year managed to avoid being classed as systemically important by global regulators. The Financial Conduct Authority’s focus on whether managers, investment consultants and service providers deliver a good deal is a worthier target.
The International Organization of Securities Commissions’ decision in June that asset managers aren’t a systemic threat was probably the right call. Fund managers use less leverage than banks, and their funding profiles mean they take much less risk. Yet they may have a case to answer on competition. The Stern School of Management reckons European asset managers have earned a return on equity 5 percentage points higher than their cost of equity, suggesting excess returns.
This could just be because punters really value their product. But a fair bit of rent-seeking looks to be going on. Take closet tracking, where a manager charges a full “active” fee of say 1 percent, but much of its investment decisions are closer to tracking an index, where fees can be less than 10 basis points. If 80 percent of a portfolio is really a tracker, then the fee should be 28 basis points.
The FCA could also look closely at how clients are charged for third-party services, such as trading or hedging costs or asset custody, which may hide hidden fees through cross-subsidies. Research is another area. The future European Markets in Financial Instruments Directive should make the cost of investment bank research clearer, but won’t do much to make it more competitive.
The stakes are pretty high. UK fund managers control 6.6 trillion pounds of assets, which will rise as investors get more say over their retirement decisions. Poor competition erodes savings, and leads to bad allocation of capital. It also may be a warning for banks across Europe, many of whom are bulking up in fund management at a time when the traditional business of lending is challenged by regulation and low interest rates.
The question is whether the FCA has the appetite to fend off industry lobbying. Its last boss Martin Wheatley was ejected by UK Chancellor George Osborne for being too tough on banks. Cutting waste should be a vote winner, but not if voters don’t even realise the costs they are paying.