EU fund managers remain entrenched on fund retrocessions, while the UK has tentatively shown that banning commissions could be healthy for the funds industry. By Nick Fitzpatrick.
The years-long quandary about fund costs came back to the fore in the EU in May when the European Commission adopted the Retail Investment Strategy, which aims to achieve fair treatment for retail investors.
The level of costs and the transparency of how costs are displayed have vexed the funds industry for years – and the temperature on this issue only increases when commissions paid to fund distributors, an intrinsic part of costs in many funds, are thrown in.
The EC Retail Investment Strategy – championed by Mairead McGuinness, Commissioner for Financial Services – once again opens the debate on the murky world of ‘inducements’, also known variously as commissions, rebates and retrocessions.
The EU will not follow the lead of the UK and the Netherlands by banning inducements completely. Instead, the proposal is for a partial ban. ‘Execution-only’ products – where no advice is given – are in scope.
The UK industry – where funds are largely distributed by independent financial advisers, wealth managers, digital platforms and banks – banned commissions in January 2013 with the introduction of the Retail Distribution Review (RDR). The Netherlands has taken a similar measure.
In the EU – where the fund distribution landscape is dominated by banks – that resistance is still there, including from organisations representing investment funds.
The RDR introduced ‘clean’ share classes – share classes absent inducements – and research has found that lower fees and higher levels of assets under management (AuM) have resulted since then for funds with clean share classes.
Fees down, assets up
Back in 2021, Fitz Partners showed that the ongoing charges figure (OCF) for clean share classes in many cross-border European funds domiciled in Ireland and Luxembourg (and which invested in equities) fell by 7% and their assets climbed 86%.
However, over the same period – 2016 to 2020 – it was also shown that share classes that still had distribution costs ‘bundled’ into them also saw assets rise and fees drop, albeit to a lesser extent: fees fell just 1% and AuM rose 25%.
Whereas the UK and the Netherlands stamped out commissions to distributors, in the wider EU, policymakers opted – through the 2018 introduction of MiFID II – to make fund managers unbundle commissions from other fund costs and be transparent about them.
The EU Retail Investment Strategy resurfaces the issue. After all, a key point is to see that customers are treated fairly. Being in different share classes may mean they are not.
“We’ve been talking about costs for ages,” says Hugues Gillibert in reference to the funds industry. Gillibert is chief executive of Fitz Partners. “I guess the European Commission decided that still not enough was being done.”
Big move in pricing
However, the state of costs now is different from 15 years ago, he says. The introduction of stricter regulations towards fee transparency as well as market forces have come into play, principally through the rise of cheaper active funds and the increase in the number of passive products, which forced asset managers to reduce fees in the name of competition.
“This has certainly worked for newly launched funds but less so for older funds. When we review funds that were launched ten years ago, we see that the average cost has not moved much, depending on the share class. Both retail and institutional share classes are slightly down.
“But for newly launched funds, there has been a big change and the price point is lower,” says Gillibert.
However, he puts this down to the rise of cheaper, passive funds competing strongly with actively managed products, supported by investors’ easier access to quoted fund charges levels.
The data, therefore, may point to a correlation, rather than a causation, between falling levels of fees and the emergence of clean share classes. Nevertheless, the correlation is notable.
“In clean share classes – those with no rebates in them – price points are now very close to institutional share classes, and so the launch of the Retail Investment Strategy could be to do with the fact some people in bundled share classes are not being treated the same as those in clean share classes.”
The EC notes that products and services offered to retail investors “often carry high fees and commissions which have a negative impact on their return on investments”. In 2021, retail clients were charged on average around 40% more than institutional investors across asset classes, the EC said, citing research by the European Securities and Markets Authority, Europe’s financial markets regulator.
“Major disruptive consequences”
Although the Retail Investment Strategy only proposes a ban on inducements for execution-only sales of financial products, even this measure is not appreciated by some of the fund bodies in Europe, including the European Fund and Asset Management Association (Efama) and Germany’s BVI.
In a statement following the release of the Retail Investment Plan, Efama said: “Although the Commission declared it had abandoned its original plan to fully prohibit commissions in the distribution of investment products and insurance-based investment products due to potential disruption to the market, there are many prohibitions to the payment of commissions in the … proposals, and these would still have major disruptive consequences for the European financial sector and consumers’ access to investment and insurance protection.”
Efama – which delivered its statement jointly with other finance trade groups – said its comments were “high level” for the time being while other areas of fund regulation were still being assessed.
“These measures will not further increase the current level of investor protection, which since MiFID II is already very high”
Also at the time, Thomas Richter, chief executive officer of the BVI, said the BVI opposed the commission ban in respect of non-advised sales, as well as the additional requirements regarding commission-based advice.
“These measures will not further increase the current level of investor protection, which since MiFID II is already very high,” he said.
Other research has also shown how fund charges for investment funds governed by the EU’s Ucits regulations have fallen over time. An October 2022 report from ICI Global, a trade body, showed average ongoing charges for equity Ucits fell 19% between 2013 and 2021 (from 1.49% to 1.21%). Fixed income Ucits saw the average ongoing charge decline 31% (from 0.98% to 0.68%).
The research also shows that Investors tended to concentrate their assets in lower-cost Ucits, which is a concern for Efama. The body says that the strategy’s “best interest of the client” test “disproportionately focuses on costs” and may lead clients to prioritise the cheapest product over others that could potentially offer them greater value.
“Misleading comparisons”
ICI Global warned against making snap decisions from comparisons between the costs of clean and bundled share classes.
“Retail investors still pay for the cost of distribution even when it is not included in the total ongoing charge. Direct comparisons of average ongoing charges between Ucits share classes that ‘bundle’ distribution in the ongoing charge with those that ‘unbundle’ distribution from the ongoing charge can be misleading. In unbundled share classes, retail investors typically pay distribution costs directly out of pocket,” ICI Global said in its ‘Perspective: Ongoing charges for Ucits in the European Union’ report.
Resistance in the EU industry to the banning of retrocessions is widely seen to be due to the power of the banks, which earn commissions for distribution.
“Direct comparisons of average ongoing charges between Ucits share classes that ‘bundle’ distribution in the ongoing charge with those that ‘unbundle’ distribution from the ongoing charge can be misleading”
But in Efama’s view, there is a legitimate question to ask about whether the business models of the UK and Netherlands are superior to that of much of Europe where retrocessions are still widely used.
Like ICI Global, Efama has warned that clean and bundled share-class comparisons could be too simplistic to conclude that clean share classes are cheaper overall.
“The truth is that these charges are lower because they exclude the fees paid by investors to receive financial guidance or advice,” wrote Bernard Delbecque, Efama’s senior director, economics and research (‘Association Column’, Funds Europe, February 2022).
Investing in a clean share class would likely mean the investor accessed the fund through a platform and therefore might have received external advice. Any advice or platform cost would increase the overall cost, even in clean share classes.
Owing to a lack of data, Efama commissioned Fitz Partners to research the topic and found that the share of costs of distribution and advice in the total cost of ownership of an active Ucits averaged 38%. Remarkably, passive funds, which on average have lower costs than actively managed funds, pay the same percentage of ongoing charges to distributors.
Inflationary pressures
There is no doubt that cross-border fund costs have decreased over the past ten years. The question is whether the RDR in the UK and clean share classes are the cause, or whether it is down to better fees disclosures coming from the number of regulatory initiatives over the past few years and to market forces stemming from the rise of passive investing.
But one thing is certain. In the current high inflationary environment, many providers of goods and services are – by definition – increasing prices to cope with the inflationary pressures they are under. But not asset managers, it seems.
Years of consumer and regulatory pressure to lower costs make it very difficult for the vast majority of funds to hike prices now.
Gillibert notes: “Everyone complains about inflation and the fact that businesses are putting up prices. But funds seem to be the only sector where prices cannot be raised!”
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