We looked at the processes used by different Authorised Fund Managers (AFMs) when they carry out assessments of value (AoVs or 'Value Assessments') for the funds they operate. Here we set out our findings.
Who this applies to
- authorised fund managers
- governing bodies of authorised fund managers (“Boards”)
- Independent AFM directors
What you need to do
All AFMs should review our findings and assess the quality of analysis and decision making within their own processes and the judgements reached by AFM Boards, as required by COLL 6.6.20R and COLL 8.5.17R. They should consider whether the action they take to address identified value concerns is appropriate.
The Collective Investment Schemes sourcebook (COLL) rules require AFMs to carry out a Value Assessment at least annually (COLL 6.6.20R and COLL 8.5.17R), to report publicly on the conclusions of the AoV (COLL 4.5.7R(8) and COLL 8.3.5AR(5)), and to appoint independent directors on AFM Boards (COLL 6.6.25R and COLL 8.5.20R). These rules came into force in September 2019 as one of the remedies from the FCA’s Asset Management Market Study (AMMS) Final Report in June 2017.
The AMMS found evidence of weak demand-side pressure on fund prices, resulting in uncompetitive outcomes for investors in authorised funds. The COLL rules address this by requiring firms to assess whether fund fees are justified by the value provided to fund investors, using the minimum considerations prescribed in COLL 6.6.21R (we refer to these as the “minimum considerations” or “considerations”). Details of these assessments must be reported to investors together with a clear explanation of what action has been or will be taken if firms find that the charges paid by investors in the funds are not justified.
AFMs should now have completed at least 1 full round of AoVs and published accompanying reports. We wanted to see how well firms have implemented the rules so that we could review the quality of the assessments and the judgements the firms are reaching on the value their funds provide to investors.
2. What we did
Between July 2020 and May 2021, we visited a sample of AFMs (18 firms, covering different business models and sizes) to review their AoV arrangements. We interviewed staff and directors to understand their processes, the inputs they used and their governance structures. We used case studies on funds we selected to explore how they assessed value against the minimum considerations.
We evaluated our findings against requirements and guidance in the FCA Handbook. This includes COLL requirements for undertaking the AoV, the report content and obligation to notify investors, and the requirements for independent directors on the AFM Board. We also considered other relevant rules including COLL 6.6A.2R, COBS 2.1.1R and COBS 2.1.4R.
3. Summary of our findings
Most of the AFMs we reviewed had not implemented AoV arrangements we expect to be necessary to comply with our rules. Many had not implemented assessments meeting the minimum consideration requirements and several practices fell short of our expectations.
AFMs often made assumptions that they could not justify to us. For example, some assumed that existing fund charges already reflected shared economies of scale. This undermined the credibility of their assessments.
Many firms did not properly apply some of the minimum considerations, including performance and AFM costs and classes of units, which meant that assessments were not properly completed.
Some firms assessed value only at a fund level rather than by unit class, as required by COLL 6.6.20R(2) and COLL 8.5.17R(2). This meant firms potentially overlooked poor value in unit classes, leading to some firms concluding high fee funds and unit classes provided value without firms completing an appropriate assessment.
When considering a fund’s performance, many firms did not consider what the fund should deliver given its investment policy, investment strategy and fees. These firms often assessed the value provided by a fund’s performance by comparing it with the fund’s stated objective, irrespective of whether this objective reflected how the fund was managed, and what the fund’s fees suggested the manager should be trying to achieve.
This was particularly apparent for funds that charged a fee commensurate with active management (ie with the aim of outperforming market returns), and were managed with the aim of outperformance, but had a more limited stated objective of achieving ‘long term capital growth’, or similar wording. Because markets have generally been rising in recent years, AFMs with these funds often assessed the funds’ performance consideration as providing value even where they have underperformed the markets in which they are invested. It is important to stress that funds which generate positive returns do not necessarily deliver good value.
Many of the firms we reviewed cut the fees for some of their funds following the completion of value assessments. The largest fee reductions we observed were to unit classes sold directly to retail investors rather than via intermediaries. Here, firms identified value concerns using the classes of unit consideration in COLL 6.6.21R(7).
Some firms also cut depositary and administration fees, following negotiations with outsourced service providers. Firms were typically less active in analysing the fees paid for asset management and distribution services, which are often undertaken by affiliates (or by fund sponsors and delegated managers in the case of Host AFMs). These fees normally represent the largest portion of a fund’s ongoing charges figure (OCF). We expect firms to focus more on these services and whether the fees charged for them are justified. A few firms introduced fee scales with break points to enable the benefits of scale economies to be shared with investors as funds grow.
Some of the independent directors on AFM Boards did not provide the robust challenge we expect from them and appeared to lack sufficient understanding of relevant fund rules.
4. How firms should use our findings
Each AFM Board should consider this review and how they should apply it to the way the AFM conducts future AoVs. Where necessary, the AFM should implement appropriate changes. We expect to find firms complying fully with our rules when we next review them.
5. Key findings
5.1. How the AoV Rules were applied
We found AFMs used a wide range of operational practices to support their AoV processes. Our rules do not prescribe how an AoV is conducted, aside from specifying the 7 minimum considerations and certain other matters. This means that there are different ways for firms to complete an AoV and comply with our rules.
Firms that we judged to have good overall AoV frameworks used different approaches, but each had clearly defined procedures and metrics for collating and presenting information to AFM Boards. These AFM Boards then used the assessment criteria to make informed decisions about funds’ value. At other firms, it was unclear what information the AFM Board used to perform value assessments, or information was either insufficient or poorly designed to enable a proper assessment. Even when firms had good frameworks, we often saw a gap between the data being provided by the frameworks and the value conclusions reached by AFM Boards, which firms could not explain to us.
Some firms with clearly defined frameworks for assessing value did not sense-check their outputs to ensure their conclusions reflected the AFM Board’s overall view of a fund’s value. For example, some frameworks gave a much heavier weighting to a fund’s performance than to the other 6 considerations. This meant potential value concerns in areas such as economies of scale or AFM costs were not escalated to the AFM Board. Poor value can arise in funds despite positive investment returns.
Conversely, where fund performance was poor, we saw examples where little emphasis was placed on poor fund performance relative to other COLL 6.6.21R considerations. These firms struggled to explain why this was the case. AFM Boards need to question frameworks that place too much emphasis on individual considerations.
Some firms were assessing value in the abstract, rather than weighing up the value delivered against the costs and charges investors pay to invest in the fund. This meant funds were often assessed as providing value even though fees were relatively high. Each AFM is required by COLL 6.6.20R and COLL 8.5.17R to assess, at least annually, whether fees can be justified in the context of the overall value delivered. Firms should ensure this is clearly embedded within their future assessment frameworks.
We saw some merging of the assessment criteria, with several criteria sometimes being considered at once, effectively using the same assessment. This happened most frequently with the consideration of AFM costs, economies of scale, comparable market rates and comparable services. Each consideration covers a different perspective on value and we expect each to be assessed separately.
We saw firms misapplying the performance, AFM costs and classes of units considerations.
5.2. Assessment of service quality
An AFM is required to consider the range and quality of services provided to fund investors when assessing whether fees and charges can be justified. Firms generally showed how they thought about each of the key elements of the service and went to varying lengths to create metrics to judge their quality.
Many firms considered the quality of the investment process as part of this consideration as in COLL 6.6.22G(2). Some, however, did not. Instead they judged the investment process through the lens of performance only. Professional fund selectors typically review the quality of an investment process alongside the performance it has generated in the past to provide a more informed insight into likely future performance. We consider that AFM Boards should do the same.
Many firms considered service quality only at a firm level rather than by fund and unit class, even when variations in service levels between funds and unit classes were likely. Firms could not provide evidence for why a one-size-fits-all approach was appropriate, or what might trigger a fund or unit class level service quality assessment.
A few firms placed emphasis on intangible matters such as ‘trust in the brand’ rather than more quantifiable measures. Sometimes this was based on data from investor surveys, despite respondents not being asked why they trusted the brand. Firms also awarded scores for low investor complaints volumes and a low number of breaches of COLL rules in managing a fund. We suggested that complaints and breaches were metrics reflecting poor service and should be recalibrated and used as deductions from scores for other, positive service-quality measures rather than as positive contributors to the scoring.
A firm referenced an ESG service that had been integrated across a wide range of funds, but it couldn’t explain to us why this justified the quantum of the additional fees it charged for these funds versus its non-ESG range.
5.3. Assessment of performance
A few firms assessed the gross performance of their funds, rather than net performance, as required by COLL 6.6.21R(2). Other firms assessed net performance but only for one of the unit classes available, typically the wholesale unit class with the lowest charges. This meant that potentially poor performance experienced by more expensive unit classes was not being assessed. COLL 6.6.20R(2) and COLL 8.5.17R(2) require a separate assessment for each unit class.
Fund performance assessed using measures that don’t reflect a fund’s investment policy and strategy
We asked firms to explain any changes they made to funds’ stated investment objectives following rules and guidance introduced by PS19/4, another of the AMMS remedies.
A few firms comprehensively reviewed their funds’ stated investment objectives and revised those for funds that were actively managed and used a comparator benchmark; they changed them from an absolute return, ‘capital growth’ objective to an objective of outperforming the comparator benchmark. These firms correctly aligned their funds’ stated investment objectives with the active-management investment policies and strategies they use. They set themselves a set of challenging but fair benchmarks against which to assess the value of the performance funds had delivered.
Most firms with actively managed funds retained their funds’ ‘capital growth’ objectives rather than changing them to reflect the active-management policies and strategies the firms used. COLL 6.6.21R(2) states an AFM should have regard to a fund’s investment objectives, policy and strategy when considering performance over an appropriate timescale. We observed many of these firms having regard only, or predominantly, to a fund’s ‘capital growth’ investment objectives, with insufficient focus on its policy and strategy.
Firms assessed funds’ performance as providing value because capital growth investment objectives had been achieved - markets generally rose during this time - despite many funds underperforming their comparator benchmarks. The firms acknowledged the funds’ active management strategies and that no specific techniques were used to manage to an absolute return target.
These funds charged fees in line with active management and firms could not demonstrate to us how they had determined the funds’ performance to provide value in the context of the fees they charged. We also noted that some of these firms rewarded the funds’ portfolio managers based on their ability to outperform the comparator benchmark, not absolute returns. Where a firm has insufficient regard to a fund’s policy and strategy when considering the value provided by performance, and focuses only, or predominantly, on a fund’s investment objectives, we consider that this firm is likely to fall below what is required by COLL 6.6.21R(2). Firms should check their value assessment processes in this area. Firms should also review their active funds’ objectives and change them if they are not sufficiently aligned with investment policies and strategies.
Some firms that set active fund objectives consistent with fund policies and strategies told us they faced a competitive disadvantage when reporting their AoV findings versus those firms that used a ‘capital growth’ objective, because their performance assessment was inherently more demanding, meaning that more of their funds were rated as red or amber.
Under-performance attributed to an undisclosed investment style
We saw some firms attributing their funds’ under-performance (relative to a comparator benchmark) to the manager’s style of investing. Firms explained that their investment style had under-performed the market(s) in which they invested for some years. Despite this they assessed the funds’ performance as providing value, even though the manager’s style of investing and the risks of relative under-performance for long time periods attached to it had not been clearly disclosed to investors.
These firms did not make plans to update customer-facing fund literature, such as KII documents and factsheets, to disclose the manager’s fund strategy and its risks. Several of them had no specific plans to discuss whether the strategy should be changed and did not set under-performance trigger points at which such discussions would be held.
Multi asset funds’ and funds of funds’ performance assessed against peers rather than the value they added
Some AFMs operating multi-asset funds (MAFs), and funds of funds (FoFs), justified fees based solely on the performance of these funds relative to peer groups of other MAFs or FoFs. In our discussions, managers of MAFs acknowledged that the purpose of these funds was to add value to investors by seeking to enhance performance and/or to reduce risk, versus single asset class funds, by using a fund manager’s skill to take asset allocation decisions.
Managers of FoFs acknowledged that a FoF’s purpose is to enhance risk adjusted returns by choosing best-of-breed fund managers in whose funds to invest, rather than leaving this decision to the investor. MAFs and FoFs typically charge additional fees for these services compared to funds that don’t allocate between asset classes or choose between managers.
These firms had typically not considered whether there might be better performance measures to assess the value provided in return for the additional fees, rather than a comparison with a peer group of other MAFs or FoFs.
We suggested to MAF managers, for example, that they might consider comparing their funds’ risk adjusted net performance with that of funds that invest only in the markets to which their funds are most exposed. For example, a MAF might currently be 75% exposed to global equities, with the remainder exposed to fixed income, property or other asset classes. Such a fund’s risk adjusted performance could be compared with funds investing 100% in global equites to gauge how much value the fund manager’s asset allocation decisions are adding. Using this approach, in some cases, we were able to show firms funds in their own range, apparently with better risk adjusted returns than their MAF, that might have been better comparators for determining the value being added by the manager’s asset allocation within the MAF.
5.4. General assessment of AFM costs
We saw some good practice among some of the firms with overseas parents. For example, US groups that have a history of disclosing detailed, fund-level cost information to US mutual fund boards (section 15c of the US Investment Company Act of 1940 requires US fund board directors to request and evaluate information needed to evaluate a fund’s contract terms. The “Gartenberg Factors” inform the nature of the information requested).
However, many firms incorrectly implemented the requirement in COLL 6.6.21R(3) to assess ’in relation to each charge, the cost of providing the service to which the charge relates, and when money is paid directly to associates or external parties, the cost is the amount paid to that person’. Rather than seeing this as a consideration of fees and charges incurred by investors in the context of costs incurred by the AFM in operating the fund, firms compared total fund charges with those of competitors’ funds.
These firms typically repeated the same comparison when assessing charges under the comparable services consideration in COLL 6.6.21R(6), meaning that the fund was, in practice, assessed using one consideration rather than two. This meant that the AFM costs consideration was not undertaken correctly by these firms and value concerns were potentially overlooked.
Where firms did interpret the AFM costs consideration correctly, we saw some assumptions used that the firms could not justify. We saw a firm using the median fund profit margin within the firm’s fund range as the benchmark against which each fund’s profitability was then assessed. Only if a fund exceeded the median by a pre-set margin was there any consideration of whether fees and charges could be justified.
Another firm started from a 40% profit margin expectation that was agreed with the firm’s parent and was consistent with historical fund margins. The firm carried out further assessment work only where funds were earning materially more than 40%. We consider that both approaches were too limited as they were based on firms’ assumptions, not backed by any analysis the firms could show us, that the status quo profit margins were justified, with changes only considered for material outliers. The AMMS found profit margins in general were not consistent with competitive outcomes.
A better approach would have been to consider profit margins that might exist if demand side pressures were stronger.
We saw one AFM that had identified benefits from economies of scale it enjoys as a fund grows. However, instead of considering whether these benefits should lead to a reduction in the fees charged to investors, the AFM had agreed to pass cost savings on to the delegated asset manager by giving them a greater share of the fund’s OCF, without any commensurate increase in service level from the asset manager. The firm did not satisfy us that the additional payment to the delegated asset manager represented good value for the fund’s investors, nor that it acted in investors’ best interests.
5.5. Assessment of economies of scale
Like our observation for AFM costs, firms that are part of wider international groups have typically more developed methodologies for evaluating economies of scale. For firms in US groups, this reflects a history of disclosing information to inform the 15c process, while firms in European groups have been able to adapt pre-existing divisional budget processes.
Most firms acknowledged that economies of scale arise at both fund and firm level. However, some have made very little progress in developing a methodology for measuring them to date. Where some firms have made progress and, in some cases, modelled fund costs in considerable detail, they typically couldn’t demonstrate how this work was used in Board discussions. This is disappointing and we need firms to complete their work in this area.
1 firm assessed economies of scale by considering whether funds had grown materially since the last time the firm compared its funds’ fees and charges with those of competitor funds. If this assessment identified a fund that had grown in excess of a pre-agreed percentage threshold, a second more in-depth assessment was triggered to assess the evidence for unshared economies of scale. The firm made a clear assumption that economies of scale were being appropriately shared at the time of the last fees and charges comparison.
This firm assumed that market rates represented competitive outcomes, reflective of shared economies of scale. So, if a fund charged no more than the market rate, it must have shared economies of scale appropriately at the time of the fees comparison. We know from the AMMS this is not the case. Funds’ fees tend to bunch around certain price points with abnormally high profit margins, and fund managers tend not to compete on price. For this reason, we consider the firm’s assessment process was built on a false premise.
Another firm performed an apparently sophisticated assessment of profitability at fund level, allocating costs at a granular level to capture the full costs of operating each fund. However, the staff involved in the final assessments could not show us how this data was processed to reach conclusions that there were no economies of scale that were not already reflected in a fund’s price.
1 firm’s modelling of costs looked quite detailed, but relied too heavily on allocating costs based on fund size rather than a more precise analysis of the actual costs of operating each fund. This allocation approach meant that the model showed larger funds did not benefit from scale economies beyond a certain size.
The firm acknowledged the weakness in its assumptions but we were disappointed to note that they did not undertake sufficient additional work outside of the standard model to reach any conclusion about whether additional economies of scale exist on the relatively small number of larger funds.
5.6. Assessment of comparable market rates
An assessment of comparable market rates was conducted by all participants with varying degrees of detail. Most firms compared at least one of their unit class OCFs (typically for the ‘clean’ wholesale unit class) against a relevant peer group and we saw several fees were cut as an outcome of this analysis. However, COLL 6.6.20R requires a separate consideration of each unit class.
We found instances of higher-charging unit classes, costing investors significantly more than the peer group median, excluded from firms’ assessments. The potential for further fee cuts was, therefore, overlooked.
1 firm was planning to switch a fund from an active to a passive strategy (reducing fees accordingly) following a comparison of the value provided by the active fund versus another fund in the firm’s range. This is an example of a firm proposing a remedy involving more than a cut to fees.
5.7. Assessment of comparable services
A few firms performed a thorough comparison of the rates charged by affiliates for asset management services and implemented fee break points within agreements so fund fees were cut in line with the terms agreed for similar, segregated mandates.
Some firms argued that because asset management service levels provided to authorised funds were different from those provided to institutional investors such as pension funds, it was difficult to draw meaningful comparisons. These firms typically did not consider whether the additional fees paid by the authorised funds versus those paid by segregated mandates could be justified by the complexity of the additional service levels.
Some firms misapplied this consideration. They had not compared fund charges with those of segregated mandates, despite appearing to manage similar-sized mandates with similar investment objectives and policies.
5.8. Assessment of classes of units
We saw some good progress in this area with many firms using another AMMS remedy to switch investors in bulk to cheaper unit classes where there was no obvious reason why they should continue paying more to be in the existing class.
However, in other cases, we found this was another consideration where some firms did not implement our rules correctly.
The combination of COLL 6.6.20R/COLL 8.5.17R and COLL 6.6.21R(7) requires firms to justify fees at unit class level, taking into consideration whether it is appropriate for investors in one class to pay more than is charged by other classes with substantially similar rights.
Instead, some firms checked whether investors are in the cheapest class given the size of their investment and the distribution channel used to sell the fund to them. The firms notified investors for whom a more advantageous class might be available, applying these criteria. However, it does not directly follow that the remaining investors in higher charging classes receive good value, simply because they are in the class appropriate to the size of their investment or reflecting how the fund was sold to them.
5.9. Quality of reporting
Firms are required to issue an annual report in accordance with COLL 4.5.7R(8) and COLL 8.3.5AR(5), setting out a description of the assessment of value. This must include a separate discussion and conclusion for each of the minimum considerations, a conclusion on whether fund fees are justified in the context of overall value delivered, and an explanation of actions taken or to be taken, where this is not the case.
Firms exhibiting good practice structured their reporting carefully to meet these requirements and made sure investors could easily see how the specific fund they invest in was assessed against each consideration and the conclusions the firm reached.
They provided useful charts and graphics showing, for example, how funds performed against comparator or target benchmarks, so readers could quickly assess their funds. Their reports were easily accessible on websites and via search engines.
Even where fund ranges were large and a firm reported using a composite report for all their funds, these firms made it easy for investors to navigate to the fund(s) reports they were interested in.
We recommend firms review their peers’ reporting and enhance reporting where necessary. They should also check that their reporting meets all of the requirements in COLL 4.5.7R(8)/COLL 8.3.5AR(5) and correct deficiencies before their next report.
Some firms argued investors are overwhelmed by over-lengthy reporting. We are not persuaded that this is the case if reports are carefully constructed. We also note that stakeholders other than fund investors use these reports and can provide additional transparency around fund value for investors. It is important that they have the appropriate level of information they need to do this.
5.10. Independent directors’ contribution
Our rules require an AFM Board to have at least 2 independent directors (or 1 quarter of all its directors if greater). We introduced this rule, with the AoV requirement, to encourage independent challenge of executive directors during the AoV process, especially where the firm and executive directors face potential conflicts of interest.
We saw good examples of independent non-executive directors (INEDs) who were well-informed of the findings of the AMMS Final Report and of the subsequent AoV rules. They were also knowledgeable about their firm’s funds and the frameworks underlying the AoV processes.
They worked with an open mind and without preconceptions before seeing the evidence about the value funds offer. These tended to be the INEDs providing the best input into the design of the framework and the best challenge to executive directors in deliberations on each fund’s value.
However, in many cases, INEDs did not have a good understanding of the AoV rules or of the role expected of them. They did not challenge the way executive staff and directors approached AoVs and could not show us evidence of how they considered the minimum considerations from an investor’s perspective. We expect independent directors to ask the difficult questions we asked in this review; in practice we did not observe enough independent directors doing this.
A small number of INEDs seemed antagonistic towards the aims of the AoV process, which causes us to question whether they are likely to perceive their roles as including making judgements on whether the AFM is managing the fund in the best interests of unitholders.
COLL 6.6.25R and COLL 8.5.20R require AFMs to appoint INEDs who are independent in character and judgement, and have sufficient expertise and experience to make judgements on whether the AFM is managing the fund in the best interests of unitholders. The role of the INED should include providing input and challenge as part of the AoV process. Firms should consider whether their INEDs are demonstrating these capabilities and behaviours.
6. Next steps
We expect all AFMs to consider these findings and use them to assess their AoV processes. Where necessary, they should make changes to address shortcomings. We intend to review firms again within the next 12 to 18 months and we will assess how well firms have reacted to our feedback. We will consider other regulatory tools should we find firms are not meeting the standards we expect to be necessary to comply with our rules.