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Are Funds Providing Value to Investors?

Funds will have to reveal whether they have provided value to investors under new rules that come into effect on 30 September

Andy Pettit 12 August, 2019 | 10:39AM

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On 30 September, new rules come into effect that are designed to ensure fund groups act in investors' best interests.

The Financial Conduct Authority will require that the board of every fund comprises at least 25% (and a minimum of two) independent directors.

The change will bring funds, where there are currently no rules around the make-up of a board, more closely in line with investment trusts, where the majority of the board must be independent. 

Along with the chair of the board, one of the key responsibilities of these so-called iNeds will be to oversee each year a detailed internal assessment of whether their funds have provided value to investors. What's more, a summary of the full assessment will need to be made public each year within four months of a fund's accounting year-end.

With the rules coming into effect on 30 September, the first value assessments will be due at the end of January. One which will likely be eagerly awaited will be that of the high profile, currently suspended Woodford Equity Income fund. Its report will be due by 30 April 2020. It promises to be an interesting read amid ongoing criticism that charges continue to be levied on investors while the fund remains suspended - now expected to continue at least until the end of the year.

The regulator has stipulated seven factors that must be considered as a minimum in making this assessment, but has been deliberately non-prescriptive in defining the assessment process and the content of the summary statement. The minimum criteria cover quality of service; performance; costs (in four different guises); and the difference between different share classes. 

The performance component of the value offered by the fund will likely be difficult to explain. Over the year to 31 July, and depending on which share class an investor was in, the Woodford fund had lost more than 21% of its value (based on the price valuations that the fund continues to make on a daily basis, albeit not realisable due to the suspension of dealing). The new rules do not require relative peer group performance comparisons, but for context, the FTSE All Share, the fund's stated benchmark, gained 1.2% over the same period. 

In contrast to the performance assessment, the cost factors do require an element of comparison with peers. The four areas that must be considered are -

  • General costs: these include the components of the ongoing charge figure as well as entry and exit fees, and need to be considered in terms of whether each charge is reasonable in relation to delivering the funds objectives. Morningstar’s qualitative analysis of the Woodford fund, for example, finds that the ongoing charge for the C GBP Acc share class (available on most fund platforms) is 0.75%, which sits within the second-cheapest quintile of ongoing charges for clean share classes of UK equity funds.

  • Economies of scale: must be examined in terms of the extent to which savings could be achieved as a result of economies of scale. Since the rules refer to "whether a fund has grown or contracted in size", the dwindling of assets may well lead to an explanation of dis-economies of scale - i.e. where assets have fallen but charges have not increased

  • Comparable market rates: this entails an external comparison with the market rate for comparable services. While this aspect might be challenging for a number of companies, Link Financial, the authorised corporate director of the Woodford fund, is in a position of also being ACD to many other funds and thus has easy access to comparatives.

  • Comparable services: this aspect is the inverse of the prior point, focused on comparing the costs of similar mandates that the firm runs.

When assessing the quality of service, a fund will presumably be considering plenty of data to measure factors such as number of complaints, average response times and the frequency and timeliness of communications. Even if deemed to have provided good customer service, ultimately, the suspension of the Woodford fund has severely impaired the fund’s ability to invest, which is the primary service being purchased by investors.

The final factor that must be assessed is the pricing and differentiated rights of the share classes of a fund. On this measure, the Woodford fund offers an income and accumulation version of just three share classes targeted at institutions and one at retail investors (and a further class solely for investment by the Woodford Feeder Fund (Ireland) and the investment managers’ self-invested pension plan). The vast majority of assets are invested in the C and Z share classes – the two lowest cost classes with annual charges of 0.75% and 0.65% respectively. 

Boards concluding that fund charges are not justified in the context of the overall value delivered will have to provide a clear explanation of remedial actions that have or will be taken. Investors will await with interest the first value assessment summaries next January.

The information contained within is for educational and informational purposes ONLY. It is not intended nor should it be considered an invitation or inducement to buy or sell a security or securities noted within nor should it be viewed as a communication intended to persuade or incite you to buy or sell security or securities noted within. Any commentary provided is the opinion of the author and should not be considered a personalised recommendation. The information contained within should not be a person's sole basis for making an investment decision. Please contact your financial professional before making an investment decision.

About Author

Andy Pettit  Director, Policy Research (EMEA), Morningstar

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