From Our Perspective: FCA raises the game
In 2001, the Myners report raised the issue of the investment value chain and how pension funds could improve outcomes through their governance structure. It also highlighted market inefficiencies in areas like peer-group herding and investment consulting. The interaction between fiduciary duty and the provision of institutional investment services had not been so extensively explored before and the report resonated widely outside the UK.
The interim report of UK Financial Conduct Authority’s asset management market review has similar potential to highlight and benchmark best practice in institutional investment management outside the UK. It is also evident, in the intervening 15 years since the publication of the Myners report, that some of the problems it raised have yet to be adequately dealt with. New problems have sometimes arisen in the place of old ones.
The FCA interim report places the business models of asset managers and consultants within its sights. For retail and smaller institutional investors, a lack of negotiating power on fees is seen as detrimental and for this group the £109bn (€130bn) invested in low tracking-error active funds is seen as a key issue.
Worryingly, the governance effectiveness of smaller pension funds, representing a significant proportion of UK pension beneficiaries’ assets, still appears to be sub-optimal some 15 years after the Myners report raised the issue. Barely 100 or so UK pension funds have assets of over £5bn and there is a long tail of much smaller schemes in the PPF universe, which extends to over 5,700 in total.
The contention is that asset managers and large investment consultancies have profited from the smaller end of the UK pension fund market by converting clients to fiduciary management. This market is now worth £123bn, according to KPMG , split into 715 mandates (459 using full fiduciary management for £71bn and a further 260 with some form of partial delegation for the remaining £52bn).
Simple mathematics on the numbers for full fiduciary delegation gives an average mandate size of just £155m, which has no doubt fuelled the FCA’s suspicion that this investor segment is not well served. Just a third of appointments were advised by a third party, although this level has improved from 23% in 2015, and just 13% of mandates are monitored by an independent third party for the life of the contract.
The Myners report highlighted the concentration in the investment consulting market; the FCA report notes that the top three consultancy firms have around 60% of the market between them. Nine in 10 investors have not switched in the past five years.
The FCA interim report highlights real market inefficiencies that are affecting outcomes for members in the UK’s largest long-term savings pool. It is easy to point the finger of blame at service providers and while the picture is nuanced, many have profited over the years from inefficiencies that they neither cared about nor drew attention to.
Solutions like an enhanced requirement for asset managers to act in their clients’ best interest, or interventionist policies like breaking up consultancy firms, might have some merit. But the true issue is one of scale. Large and well-resourced institutional investors are the ones best placed to serve their beneficiaries interests by eradicating the market inefficiencies highlighted by the FCA.
The evolving asset pools of the UK’s Local Government Pension Scheme form an interesting template for not-for-profit investment management entities that allow asset owners autonomy over asset allocation and segregated assets and liabilities. The large pension-owned fiduciary managers like MN or PGGM are another. The UK has much work to do to make its pension funds work better. The problems are becoming more, not less, acute.