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Magazine Issues » June 2020

Regulation: The correct value judgements

Cost evaluation
Asked what lessons could be learnt from the first round of AoV reporting, SVM iNED Beckett – who is also a fund governance consultant – points to fund managers’ use of language and terminology. Do fund companies know their audience? And are they employing terms and metrics that are accessible to their target investors? 

“SVM Asset Management is already evaluating areas where we can improve our report for next year and one place will be in our use of language, where we will strip out jargon even further. If a glossary is unnecessary to read the report, that is good sign that the report is written in a tone accessible to its target audience.”

Some fund managers may confuse investors by complex language and jargon. Others make it difficult for investors to assess whether their fund holdings are delivering value by employing a wide range of sometimes conflicting performance measures and cost indicators.

Hargreaves Lansdown uses a wide range of cost measures in its AoV disclosure, including ongoing charges, total expense ratio (TER), ongoing charges figure (OCF), annual management charge (AMC) and net ongoing charge. This use of a range of differing cost metrics, and actively switching between them, can make it difficult for investors to understand their costs and how these compare with similar funds available in the market.

Responding to this point, Hargreaves Lansdown’s Cox says: “We will look to improve consistency of language. However, some of these terms are distinctly different and refer to different things. For example, the annual management charge (AMC) refers to the 0.75% that HL charge. This, added to the ongoing charges figure (OCF) of underlying funds held by the multi-manager and other expense charges, makes up the net ongoing charge (or the OCF of the multi-manager fund). Whilst we have tried to be clear throughout the reports what charges are being referred to, we will endeavour to make this as user-friendly as possible going forward.”

For investors requiring information on Hargreaves Lansdown funds, cost measures are displayed on the website in a range of different locations. However, these fund factsheets and documentation employ a range of different cost indicators, sometimes offering significantly different fund cost measures for a single fund. Taking the HL MM Asia & Global Emerging Markets Fund as an example, cost information is quoted in a number of places on the Hargreaves Lansdown website (Table 1).

Although the MiFID II charges – which include transaction charges and HL platform fee – are displayed on the Hargreaves Lansdown website for this Asia & Global Emerging Markets Fund (2.24%), a lower figure of 1.59% is used to assess value in the AoV disclosure. This raises the question of whether the cost assessment delivered by the AoV disclosure represents a full and accurate representation of the costs incurred by the investor.

When asked why this lower figure is used, rather than the MiFID II cost, Hargreaves Lansdown replied that “the 2.24% figure (the MiFID II OCF) includes the cost of investing via the HL platform (max 0.45%) but as these funds can, and indeed are, held by other platforms we have elected not to use this figure”.

Punter Southall Analytics’ Chadda questions whether it is appropriate to use a lower 1.59% figure, which is net of platform costs, when a large majority of investors (more than 99%) pay this platform fee to access the fund. 

“When a platform fee is taken out of a fund’s net asset value, it is a requirement to include this in the fund costs,” he says. “When this is not the case, there is discretion around including it or not. However, for all ten of the HL MM funds, the investor base is between 99.20% and 99.90% HL non-advised platform clients – who have to pay the platform fee to access any of these funds. It doesn’t represent the investor experience [to exclude the platform fee].”

In this area, there appears to be a gap between the cost assessment captured by the AoV disclosure – where Hargreaves Lansdown (and many other AFM AoV reports) utilise the Ucits OCF as a cost metric and the true investment cost (including transaction cost and platform fee) borne by a large majority of investors who access the fund via the Hargreaves Lansdown platform. For this group of investors, their investment cost is reflected more accurately by the MiFID II OCF.

One constraint to mandating use of MIFID II costs in the AoV evaluation are current concerns around data quality. In preparing the AoV disclosure for SVM Asset Management, Beckett indicates that the intention was to use MIFID II costs (ie, MiFID II OCF) throughout the process, although they were unable to do so in all instances owing to inconsistencies in the MiFID II data. 

“In some cases, the MiFID II OCF quoted in major data sources was lower than the Ucits OCF – typically as a result of funds showing negative transaction costs,” he says. “When comparing SVM’s market rates against those of our peers, it was necessary, in some cases, to utilise the Ucits OCF or another alternative cost measure to ensure a consistent comparison – and we have explained why we have done so. When assessing internal costs and those paid by investors, we have used the MiFID II OCF as fully as possible.”

Pricniples_of_FCA_assessmentThis point notwithstanding, Chadda suggests it is a question for the financial regulator why they are allowing fund managers to use the lower Ucits OCF in their AoV reports and other investor disclosures when this may under-represent the full cost of investment borne by unit holders by as much as 40%. “Any attempt to assess client value, for any good or service, must use the true costs payable by the client, or else it is meaningless,” he says.

Commenting on asset managers’ choice of value measures, the Fund Board Council’s Taneja says: “When there is not prescription [in the AoV methodology], then it is to be expected that there will be variability in how measures are used by AFMs to assess value. However, we must draw a distinction between variability and cases where an AFM is not being fully transparent. A provider may use a range of value measures, but in doing so, they must explain why – and, if it does exclude specific costs which are borne by the investor, this must also be clearly explained.”

Good agents?
With the AoV regime, the FCA aims to ensure that fund managers act as ‘agents’ of investors in their funds, ensuring that fund managers deliver value to consumers while enabling consumers to understand more about how their money is managed so they can make better investment decisions. 

The FCA indicates that it will be taking a close interest in whether fund managers have complied with the spirit of its AoV framework, the letter of the law, or neither. 

“We will work in the first half of 2020 to understand how effectively firms have undertaken value assessments. We will seek evidence of meaningful challenge on AFM boards on proposals made by the executive – including on costs, fees and product design,” says the FCA.

Taneja says: “We know from the FCA that there will be a post-implementation review to follow the first AoV reporting process. We anticipate it will retain a non-prescriptive approach, while asking AFMs to support their submissions with further supplementary evidence.” He adds that the AoV process needs to be firmly embedded within the governance frameworks that asset management companies operate. 

A feature of the SVM AoV disclosure, notes Beckett, is that iNEDs are given a high level of freedom to assess value independently of the Chair and the Board. The iNEDs met on 13 occasions over five months to define the methodology employed in the assessment and how this feeds through into the final report. 

“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 signoff. However, this is not happening in a uniform way across the industry,” says Beckett.

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