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Magazine Issues » July-August 2020

Fund governance: An exhaustive look under the bonnet

Car mechanicSVM Asset Management believes its response to the FCA's new Assessment of Value regime exceeded basic requirements. Bob Currie talks to the firm’s founder, independent directors and certain staff to find out how.

Since the Financial Conduct Authority’s assessment of value (AoV) regime came into force in the UK last year, the first round of AoV disclosures have revealed striking differences in approach by asset managers to measuring value (Funds Europe, June 2020). SVM Asset Management, which featured in our report last month,  is one fund manager whose AoV disclosure could be cited as an example of best practice.

Colin McLean, founder and director of the firm, told us: “Many within the industry have addressed the FCA’s AoV regime primarily as an initiative to drive down costs borne by the investor. However, SVM has taken a wider view of value assessment, taking this as an invitation to evaluate how investors view us as an asset manager and whether we are meeting their expectations.”

Colin_McLeanMcLean says good governance is central to delivering value. While growing numbers of asset managers are outsourcing their authorised corporate director (ACD) function – a key governance component for asset managers – the Edinburgh-based boutique manager, which had assets under management of £516 million (€570 million) on June 30, has retained its ACD function in-house and states that oversight and compliance lie at the heart of its business. 

Two independent non-executive directors (iNEDs) have been granted a central role in driving the value assessment process. One of them is a former fund gatekeeper at Scottish Widows, JB Beckett, who has wide experience of business-to-business fund distribution relationships and specialist expertise as a fund buyer and analyst.

His fellow iNED, Jonathan Hewitt – previously head of personal investing at Fidelity – applied his consumer background to assess whether retail investors are getting a fair deal from SVM funds. Both iNEDs have seats on the SVM board of directors and serve on a number of its subcommittees. They also sit on an SVM AoV working group.

Beckett says that the firm’s AoV disclosure acts as a direct line from McLean, as boardroom chairman.

The iNEDs were given a high level of freedom to assess value independently of the chairman and board, meeting 13 times in five months to define methodology and how to shape the final report and determine any action.

“It is important for the assessment framework that the iNEDs have been involved from the start, as architect and builder of the report, and not simply drafted in a few weeks before publication as recipient to the sign off,” says Beckett. “However, this is not happening in a uniform way across the industry.”

Hewitt says preparatory work around the AoV evaluation began in September 2019. This involved internal discussions around what the AoV assessment should deliver in line with the FCA’s seven AoV criteria for funds and share classes.

“We believed it important to establish a methodology before we applied live data,” he adds. “There is a danger, when the live data is already available, that an asset manager may alter its method or drop a value metric because it does not like the result.”

Value dashboard
SVM used a red-amber-green approach (‘traffic lights’) to represent its results in an AoV dashboard. Under this typology, a green classification indicates the fund adds overall value to the investor and there are no material issues. ‘Amber’ implies that it adds value but requires some management action or additional oversight. ‘Red’ means the fund is eroding the value delivered to the investor and urgent managerial action is required.

SVM’s five investment funds (each having A- and B-share classes) secured a green rating across the board for five of the seven mandatory criteria required by the FCA. However, the SVM World Equity A-class was marked as red for performance and two other fund classes scored amber in the performance category.

“Whilst still in its relative infancy, SVM World Equity Fund obtained red and amber ratings, noting that performance, to date, had not met the criteria of the fund objective,” says the report. “Management are considering actions to be taken to improve the performance of SVM All Europe SRI Fund A Class and SVM World Equity Fund (A and B classes), but we believe that the proposition still has the right attributes to deliver value to investors.”

In the ‘comparable market rates’ category – reflecting the fund charges paid by investors relative to other comparable funds in the market – one share class (SVM Continental Europe Fund B-share) was classified red and three others were flagged as amber.

SVM’s chief financial officer, Garry Fyfe, was executive lead for the AoV working group and the main point of contact that the iNEDs engaged with on a day-to-day basis. Fyfe says thresholds for the traffic lights system were defined before calculating any results and a working paper was prepared for each AoV criterion detailing the methodology, findings and points for future action. These working papers – which were approved individually and then collated into the final AoV report – also provided an audit trail to guard against potential accusations of cherry-picking metrics or retrofitting value measures.

One potential shortcoming of a traffic light system, says Fyfe, is that it can lock in a pass-or-fail mentality. But when situated in the context of a series of annual AoV reports, this provides a picture of the AoV journey over time and, with it, the improvements made as remedial actions are set in place.

Fair share
Beyond outlining a basic reporting template, the FCA avoided prescription for the AoV methodology. It has asked authorised fund managers (AFMs) to assess value against the seven core principles which must be addressed for each share class. However, a fund manager may add additional criteria.

SVM added an eighth consideration – a ‘fair share’ evaluation – designed to evaluate how investors, on average, might assess the value delivered to them. This looks at the growth in clients’ assets relative to the fees charged by the fund manager over an appropriate investment period. “Our starting point is that the fund holder should receive the majority of this return, rather than this falling to the pocket of the fund manager,” says Beckett.

Hewitt explains that in preparing the ‘fair value’ criteria, there was a lengthy debate about whether the AoV disclosure should include a cash-based performance comparison – whether the fund delivered a higher net return than holding the equivalent sum in a cash account over the investment period. However, SVM desisted from using a cash comparison measure in its 2020 submission, given that cash is not specified as a performance objective in the fund factsheets.

Performance comparators
Arguably, a standout feature of the SVM AoV disclosure is its three-barrelled approach to measuring fund performance. Some funds managers, understandably, have chosen to compare fund performance against the investment objectives stated in the fund documentation. Others have compared funds against the performance of the relevant Investment Association (IA) sector.

SVM may have gone further than its peers by calculating performance against three measures: the fund’s target benchmark (specified in the prospectus and factsheet); comparison with the relevant IA sector; and comparison with a selected peer group.

Significantly, it also assessed the percentage of months the fund outperformed the benchmark (known as ‘persistency’) on a rolling five- and ten-year holding period. This recognises that investors can subscribe into, and withdraw from, the funds at various times throughout the year and attempts to control for the impact of timing issues on performance results. 

A primary consideration for an investor in an actively managed fund is whether this will outperform an ETF or passive index-tracker – and comparing the fund’s performance against its target benchmark provides a measure of whether it meets this expectation. However, SVM included additional comparators for methodological rigour and to reflect the active investment objectives.

The firm found the IA’s full comparable sector funds lists to be “vast and unwieldy, often grouping funds with quite different objectives and investment approaches together”. The firm therefore developed a screening process to identify specific peer groups for each fund.

“The specific peer group comparators were designed as part of a marketing review that predated the AoV evaluation – and consequently we had an audit trail in place to confirm that we did not contrive a peer group simply for the purposes of the AoV disclosure,” says Beckett.

Client service and marketing review
In the months prior to its AoV assessment, SVM reviewed client service and marketing across its investor base, using a survey to assess how investors viewed SVM.

Erin ElliotErin Elliot, SVM marketing and client relationship manager, says clients indicated a priority was for rigorous controls around balance-sheet risk and key-person risk.

She adds: “SVM has a strong balance sheet, so we believe this consideration is well covered. However, for a boutique investment house with just over 20 employees, there is significant key-person risk and we are taking action to address this.”

Action has included appointing Giles Robinson as head of sales and marketing with a specific brief to raise the fund house’s profile among financial intermediaries.

Costs ranked fourth out of eight in terms of important considerations found in the survey – and, says Elliot, steps have been taken to improve its fee structures with a number of its key service providers.

This raises the bigger question of how tiered pricing structures impact a boutique asset manager. The SVM AoV report says that several funds “suffer slightly due to scale” and do not currently benefit from tiered discounts in ad valorem fee structures (charged against size of assets managed). “We receive the same service as many larger investment management firms, but our relative cost of service is higher due to assets being in the millions rather than billions,” notes the report. However, SVM does operate an ‘expense cap’ where excess charges above the cap are absorbed by SVM and not investors.

McLean, the firm’s founder, says the AoV evaluation has encouraged SVM to negotiate revised pricing structures with its service providers, including its fund administrator and transfer agent. “SVM is committed to growth and we are taking steps to build AuM through performance and new fund flows,” he says. To support this, SVM completed the launch of a new website in May and will conduct a full review of its fund factsheets during the coming year.

Beyond this, SVM’s recent move to Bloomberg’s AIM execution and order management platform, as well as greater use of cloud-based data management and service delivery options, are expected to yield further improvement in trading costs and operational efficiency.

Fyfe says that the AoV exercise has provided an opportunity to engage with fund holders to a greater level than was otherwise possible. 

He says it’s “an unfiltered ‘look under the bonnet’ of the SVM funds” that goes beyond headline performance and charges, to also consider the firm’s culture and controls, management actions, and the contribution from different parts of fund operations.

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