Authorised fund managers’ assessments of fund value 2023

All firms we visited had performed a gap analysis against the July 2021 findings, however, some had overlooked key findings or taken actions that did not address them.

A few firms wrongly judged that their size or business model meant some of our feedback wasn’t directed at them.

Directors not involved in the gap analysis often hadn't considered how well it had been performed and accepted its findings at face value. Generally, where we found these gaps, it led to a weaker AoV process being in place at the time of the review. 

Some firms had fully integrated AoV into their business-as-usual processes for product development and fund governance.

These firms reviewed AoV considerations before launching new funds and simultaneously considered the impact that any changes to funds during the year might have on the next AoV.

Other firms operated their AoV process as a stand-alone annual exercise and conducted their product strategy and governance without specific reference to AoV considerations.

These firms tended to have more difficulty demonstrating a strong assessment of value. 

Most firms’ processes were providing improved information and analysis for their AoV assessments.

However, in decision making these improved inputs were sometimes ignored or unreasonably explained away.

Firms decided current fee levels could be justified even though improved information raised significant questions or countered that position.

Some AFM Boards told us fund fees were determined by more senior committees or boards in their global or PLC Groups with AFMs having only limited influence.

We remind AFM Boards and their Senior Management Function holders (SMFs) that, regardless of inputs from their groups or other parties, they are solely responsible under COLL6.6.20R[9] for completing AoVs and concluding whether fees are justified.

We expect other parties, including group committees and boards to respect this responsibility and requirement.   

While some good challenge from independent non-executive directors (INEDs) was evident, most firms' INEDs did not provide sufficient challenge.

We found that some were too involved in the collection and analysis of information to be able to challenge its suitability subsequently.

Others thought they shouldn't review the AoV methodologies and could accept information provided to Boards at face value.

There is an important balance for INEDS. Involvement in the AoV process should be sufficient to understand the firm’s methodology, but not amount to an involvement that compromises independence.  
 
A few of the INEDs we spoke to didn’t understand their firm’s process in areas such as performance and AFM costs, or evidence an understanding of the objective of the AoV process. 

Good firms followed a meaningful process for assessing fund manager expertise and quality of investment process when considering quality of service.

They used relevant metrics to measure service provision and provide meaningful management information to Boards, enabling directors to understand quality beyond simplistic process descriptions.

One innovative and thoughtful approach involved a firm considering accurate descriptions in requests for proposals, that had been successfully used to win institutional mandates, provided some validation of investment process quality where a fund was managed to the same strategy.

Firms assessed third party fund accountants and transfer agents using metrics comparing them with other providers.   

Poorer practice seen was firms assessing the quality of its delegated managers' investment processes largely by relying on managers’ attestations about the quality of their own operations.

A small number of firms did not consider the quality of service provided by an affiliated company when assessing if the fee charged for the service was justified.

The payments for the services were a material part of the funds’ ongoing charges figure. We expect firms to consider the quality of services in the context of payments made for them.  

Firms assessed ESG under quality of service. We found good practice where some firms didn’t apply positive ESG scores for funds that were not marketed as sustainable funds, including one firm that scored its ESG delivery as neutral, at best, because it judged that its funds would not merit a label under the FCA’s Sustainability Disclosure Requirements (SDR)[9] and investment labels proposals.

This approach guards against giving credit for an ESG service level where it is in fact simply an extension of the existing investment process.

A few firms were continuing to use low complaint and investment breach numbers and the management of fund liquidity to justify positive service quality scores.

We consider these are hygiene factors that should not in themselves contribute towards service quality assessment.

They should, however, detract from scoring where there is poor performance.

We continue to see significant differences between good and poor practice in how AFMs assess their funds’ performance. Those doing it well set fund objectives and performance thresholds which reflect their investment strategies, such as an actively managed fund outperforming a market comparator benchmark over a fund’s minimum holding period, before finding good performance.

Good practice also gave poor ratings to active funds that significantly underperformed market comparator benchmarks, even where funds had achieved capital growth.

Those with poor practice placed greater emphasis on more easily achieved capital growth targets, despite the fund being managed actively and without techniques to reduce materially market risk.

One firm rated an actively managed fund as having good performance although it underperformed the market benchmark by 10% over 5 years. 

Asymmetric performance metrics

The metrics some firms applied to assess funds' performance were asymmetric. These firms used relatively undemanding hurdles for deciding a fund had good levels of performance, while the poor performance threshold was disproportionately high. In some cases, a red rating was almost impossible to achieve.

Some firms had no threshold framework for determining good and bad performance and could not explain in detail how they undertook assessments.

Measuring against market benchmarks

Where firms measure performance relative to market benchmarks, some continue to attribute long term underperformance to an out-of-favour investment style. We raised concerns about this in our July 2021 findings.

Investment styles that can affect performance for extended periods should be disclosed within a fund's Key Investor Information Document, together with appropriate risk warnings. 

Firms with good practice did not improve performance scoring of previously underperforming funds if short term improvements had not yet had an impact.

Poorer processes allowed firms to move a fund to a good assessment score even where remedial steps taken had not yet improved performance over the fund’s holding period. None of the firms we assessed reduced fees for poor performance.

Fee reductions for poor performance were explicitly considered by only a few firms despite COLL 6.6.20R[11] requiring firms to justify fees in the context of overall value delivered. 

Multi-asset funds and funds of funds

We identified significant improvement in some firms’ analysis of multi-asset funds (MAFs) and funds of funds (FoFs).

Instead of limiting comparisons with other MAFs and FoFs, these firms had broadened the scope to compare their performance with the markets to which their funds were primarily exposed.

However, others still compared their MAFs' performance only with competitors' MAFs, rather than market-based benchmarks or relevant passive funds.

Even when firms were using better comparisons initially, some did not use the improved information, often reverting to peer group comparisons to justify good performance assessments.      

Almost all firms had taken steps to ensure that fees can be justified in the context of the costs the AFM incurs in operating a fund, and not simply a comparison with competitor fees.

A few firms were confusing AFM Costs with Comparable Market Rates and so were not complying with COLL 6.6.20R[13].        

Firms with good AoV processes undertook detailed activity-based cost allocation at fund and share class levels. This typically revealed significant variations in profitability between larger and smaller funds.

This type of profitability analysis enables firms to better consider AFM Costs. It also allows firms to recognise when a fund grows and economies of scale (EoS) support lower fees.

Other firms had not built a detailed costing model or were still allocating significant costs based on funds’ relative assets under management.

This limited the ability to analyse costs at a fund and share class level. Not surprisingly, profit margin variations between large and small funds for these firms were significantly smaller, and board and committee discussions about economies of scale less informed. Firms should consider whether their current costing models adequately support AoV.  

Using fund-level profitability to inform assessments

Some firms with well-developed cost analysis did not use fund-level profitability information to inform their assessment. Instead, they preferred using comparable market rates comparisons, to override both EoS and AFM costs conclusions. We expect firms to give each consideration in COLL 6.6.21R[7] due attention. 

The best practices in EoS involved firms negotiating better prices with third party asset managers or service providers as funds grew, passing on the full benefit of these savings to fund investors through lower fees.

We saw examples where some firms extracted size benefits but retained them or didn’t scrutinise or negotiate down the fees for services provided in-house or by affiliates with the same intensity as with third parties.  

Some firms said that they had reinvested economies of scale back into the business and that this would benefit fund investors. In these cases, we were concerned that it was the firms or their general client base benefitting, rather than the investors in the funds where the largest economies were being generated.   

For the economies of scale consideration, we expect firms to discuss in product development the scale the fund needs to reach to earn a reasonable return on the firm’s investment in developing it to scale.

Where firms choose to reinvest economies of scale into the firm for the benefit of fund investors, they should be able to evidence the benefits and link them to the relevant fund’s investors.

Firms should be able to show the proportion of economies of scale accounted for by the reinvestment and how the firm assessed the remainder.

We continue to see this COLL 6.6.21R[15] consideration being used by many firms to override one or more of the other minimum considerations.

When there was evidence from another consideration suggesting that a fund's fees might not be justified, most firms switched to assessing comparable markets rates to justify current fees.

Some firms advised they would only consider cutting a fund's fees if they found they were out of line with competitor funds' fees. This is a misapplication of COLL 6.6.20R[14] consideration of all seven minimum considerations.

While the rules do not prescribe any weighting of the considerations, we consider that justifying fees solely based on a comparison with peer funds does not amount to meaningful compliance with COLL 6.6.20R[17]. Nor does it reflect the intent of the rule as a remedy for weak price competition identified by the AMMS. 

In applying comparisons of funds' fees with those of other funds, some did so without first adjusting for differences in service levels.

One example was a firm comparing its funds that do not include a platform charge within their ongoing charges figure (OCF) with competitors' funds that have a platform fee included, without adjustment.

Another firm inflated a competitor’s platform charge to reflect its own, more expensive, platform charge before comparing.

We consider these practices make favourable assessment outcomes more likely and undermine the effectiveness of the assessment process.  

We saw some good practice for this consideration. One firm used a thoughtful approach by plotting the fees paid by segregated mandate clients of different sizes to create a line of best fit. It used this to compare the fees paid by different sized funds to identify significant divergence. 

However, some poorer practices were also present. One firm concluded that lower fees for its asset management affiliate’s segregated mandate clients were due to discounts institutional clients had negotiated through their wider relationship with the affiliate.

As a result, it concluded that the firm’s funds' higher fees could be justified. But the firm did not seek to quantify the size of the discount or consider whether, as an authorised fund manager with many funds managed by its asset management affiliate, it was able to negotiate similar relationship discounts for its fund activities.

Another firm mistakenly considered the fees individual fund investors would pay for their money to be managed on a segregated basis, rather than the potential for fee discounts that an entire fund might secure, using the buying power of its pooled assets.    

Most firms had significantly improved quality of their reporting since our July 2021 review. AoV reports contain disclosure about assessment conclusions using the seven considerations and, where relevant, actions to deal with poor value. 

We continue to receive firm feedback about the cost of producing and distributing these reports to investors.

We encourage firms to consider whether the production costs can be reduced and note that our rules permit them to be contained as disclosures in funds' annual reports.