Financial Conduct Authority changes made at the end of September mean authorised UK-domiciled funds have taken a step in the direction of investment trusts when it comes to governance.
The new rules require fund management boards (AFMs) to have two independent directors to act in the interests of the end investor. A key duty will be producing a two- to four-page value-for-money assessment that will appear in annual fund reports.
While the Woodford fund suspension has highlighted the repercussions of poor governance, intermediaries are not unanimously welcoming or even aware of the changes.
Fund Expert managing director Brian Dennehy does not take fund governance into account during fund selection. “These funds are already heavily regulated and if the manager is doing something daft, it is obvious in performance long before the underlying problem emerges publicly. Woodford is just the latest example of this,” he says. Dennehy wants to know how the regulator is going to monitor the value the independent directors will add.
Beneficiaries of FCA changes not engaged
Schroders UK intermediary solutions director Gillian Hepburn says most advisers are focusing on the senior managers and certification regime coming into effect in December, and on Product Intervention and Product Governance Sourcebook requirements. “My general take is that IFAs need to be more engaged with this,” says Hepburn.
This view was borne out by the fact that several intermediaries we spoke with were barely aware of the changes. This is despite hundreds of independent directors being recruited before the 30 September deadline to champion the end investor, whether that’s retail, institutional or those with a segregated mandate.
While the first value-for-money assessments are due out in December, pricing pressure has already been linked with the regulatory changes. When the Virgin UK Index Tracker fee was cut to 0.6% in January, people were quick to point out it would have been difficult for incoming independent directors to justify the previous charge of 1% in an assessment of value statement.
That type of result would be welcome for Thameside Financial Planning director Tom Kean, who is not paying much attention to the changes. “It’s not a subject I am too focused on, although I do still ﬁnd some funds to be way too expensive,” he says.
While value might seem a subjective topic for directors to tackle, the FCA said in its interim market study that an ongoing charges fee of 0.5% for clean share classes or 1% for bundled was too expensive. No equivalent was provided for active funds, which can have a much wider array of investor outcomes.
Choosing winning funds versus managing risk
Independent director and former fund selector Jon Beckett reckons retail intermediaries can be disengaged from fund governance, so he is not surprised they are taking no notice of the FCA changes. It is pension funds and insurance companies, which have their own operational due diligence and risk assurance teams, that are more attuned to the implications, Beckett says. “Institutional investors spend more time on this, for the simple reason their investment is less about choosing winners and much more about managing risk. What they want is outcomes that are as certain as possible.”
As for advisers, multi-managers and fund-rating agencies, Beckett says they would have had relatively little contact with fund boards up to this point. They are more focused on which manager is achieving top-quartile performance, he explains. Intermediaries that are conducting more due diligence on fund governance tend to be large wealth managers or specialist DFMs.
Cornelian Asset Managers investment director David Appleton describes it as critical to fund selection. Added independent input to the oversight of funds is to be welcomed, albeit with caveats, he says. Appleton says some directors’ responsibilities span a large number of funds, spreading them too thinly. While investment trust directors are only responsible for one strategy, AFM fund boards can oversee dozens of strategies under one umbrella. The value-for-money assessment also risks becoming a box-ticking exercise, he believes.
Looking to the US for inspiration
Fund boards are likely to split into two operating models, reckons Fund Boards Council chief executive Shiv Taneja. “You’re going to have one where they’re going to stick very closely to the letter of the law of the FCA market study. That is largely going to be centred around the production, delivery, and signing off the assessment of value reporting. I think that there would be quite some number of fund boards that are going to take that take that approach.”
The FCA has outlined seven principles [see below] directors must address in their assessments of value ranging from cost and performance to whether unitholders in more expensive share classes are being treated fairly. Better-run fund boards will take a broader approach focused on improving investor outcomes, Taneja says.
UK fund boards can already look to two existing models where independent directors have long existed.
In the US, independent boards have been a requirement since the Investment Company Act of 1940. Its principles have formed the basis for the FCA’s value-for-money assessment. Mutual Fund Directors Forum chief executive Susan Wyderko believes it is no coincidence that US fund fees are the lowest of any developed economy. US boards will retain more independence than their UK counterparts after the changes come into effect, with the chairs being independent along with the majority of directors.
That is the case too for the independence model that comes with investment trusts.
Bigger paychecks won’t necessarily lure investment trust directors
While UK fund boards are more lucrative than their investment trust counterparts, Allianz Technology Trust chairman Robert Jeens says the lack of independence would fail to entice him over the trust model. Jeens, who serves on the board of several other trusts and a PLC, prefers the chance to ask the “big questions”, such as whether or not the board should stand by its manager. He believes this is beyond the scope of UK fund boards.
“I’m aware it’s proving necessary to offer quite high fees to people to take on these internal directorships as they’re less attractive to independent-minded people that want to consider the broad issues,” says Jeens.
Anecdotally, UK fund boards are paying £40,000 compared with £25,000 for the average investment trust director. He says: “All of us have to do a lot of nitty gritty compliance work. It’s absolutely essential but not the most interesting part of the job.”
Investment trusts still come out on top for governance
JP Morgan Global Growth & Income director Gay Collins questions the dynamics of a board that is not entirely independent. “We always have the same constituents in the back of our mind, which is the shareholders, the trust and reputation of the trust, and how the trust is performing,” she says. “Maybe if there’s a split between independent and non-independent it might be harder to be clear what your objectives are.”
That independence is valued by many in the investment management space.
“Investment trust governance, via an independent board acting on behalf of shareholders, is a valuable feature and one of the key positive attributes of an investment trust,” says Quilter head of research Nick Wood.
EQ Investors senior investment analyst Simon Moore says the FCA changes for open-ended funds are to be welcomed but that the investment trust space has been doing this with much more force over the past 150 years. While the Investment Association acts on behalf asset managers, Moore points out the Association of Investment Companies represents shareholders. He likes to meet with boards before investing.
But not all fund selectors consider the investment trust model up to standard.
Canaccord Genuity Wealth Management investment director Patrick Thomas likes independent boards acting on behalf of investors in theory but says it does not always work in reality. “Fund mandates often remain with teams that should really be ﬁred for indifferent or outright poor performance. There are too many trusts with no clearly differentiated purpose, and the independent boards are asleep at the wheel.”
Independence shakes up fund board meetings
Boardroom battles with fund managers don’t necessarily reﬂect good governance anyway, argues Taneja. “Governance doesn’t have to be about getting rid of people at the drop of a hat, it’s about being able to inﬂuence change in an organisation without disrupting it entirely. I appreciate that sounds a little less exciting, but that’s how it is.”
Paul Boughton, founding partner of fund board director training outﬁt MosaicNed, says ﬁnding people who can be critical yet integrate with the board is a ﬁne balance. “What you don’t want is disruptors – people that just ask questions for the sake of it.”
Franklin Templeton Investments has already had two board meetings with its independent directors, and chair Martyn Gilbey has felt their inﬂuence. “It raises standards of governance for how you run these meetings. When you have an independent director you have to make sure you’re moving from an internal management committee structure to a proper formulated external board,” he says. Franklin Templeton Investments is set to sign off its ﬁrst value assessment report in July 2020.
Woodford might be the bigger catalyst for intermediaries to consider governance
According to Beckett, the suspension of the Woodford Equity Income Fund could act as more of a catalyst than the FCA changes to prompt retail intermediaries to conduct more thorough operational due diligence. He says: “Fund selectors should have been asking whether the support functions were in place to handle the inﬂux of money. They should have detached themselves from Neil’s skill in stockpicking and fund management.”
Dennehy remains skeptical, however. He says the independent directors of the Woodford Patient Capital Trust “have added precisely no value. The Woodford problem was one of which the FCA was aware for a long time, but nothing was done”.
When it comes to value-for-money reporting, Thameside’s Kean is disappointed by existing fund documentation and transparency. “I’m not sure anything can ﬁx this 100%, so these proposed actions from the FCA will not alter the way I select funds.”
The FCA changes do indicate it wants professional investors to pay more attention to governance, says AlphaFMC head of compliance Andrew Glessing. “Advisers have been making sure they understand attitude to risk and capacity for loss in response to the FCA’s previous work, and ﬁnding fund solutions and tax wrappers that align with that, with good governance taken as read,” he says. “The asset management market study has been a catalyst for the FCA to lay down some challenges for the way it wants to see governance evolve.”