RDR, MiFID2 and the Regulatory Glare of ‘Value for Money’

RDR, MiFID2 and the Regulatory Glare of ‘Value for Money’

Where are my sunglasses, the glare of regulatory change is getting brighter for we fund buyers? Later this month I will be heading to South Africa in the latest chapter of a suitcase fund analyst. I will be there on work as author of New Fund Order, guest speaker courtesy of RMI Investment Managers, Speaking to advisers as part of their ‘AlphaCode’ club series. I will also be taking the opportunity to catch up with APFI colleagues at our South Africa chapter, led by Riad Daniels, and building relationships with local bodies like CFA and ASISA as they too head into a new regulatory era.

At the centre of all of this bodes a simple question. What is the role of the modern professional fund investor today and how can we as fund buyers deal with the other question that is vexing our industry so? What is ‘value for money’? This question is nothing new but remains elusive and has gained new vigour in recent years.

Our industry has had to deal with many new questions post Retail Distribution Review (RDR), enshrined across the EU passport (mostly) by MiFID2. In the UK, arguably the most progressed RDR market to date, we have seen a series of thematic reviews and guidance, as the UK has move from self to statutory regulation in the last decade. The UK then offers a signpost for other RDR buyer markets and markets undergoing RDR like South Africa. Those that expect RDR to bring one raft of changes may be in for a big surprise.

Morningstar reported in 2017 that “Prior to the implementation of the Retail Distribution Review in January 2013, the majority of investors dealt with an adviser, whether it was on a regular basis or to offer periodical advice at key life events. Around 50% of the UK advisers used trail commission to help meet their annual review costs. Trail commission was a percentage fee, typically around 0.5%, paid to advisers and to fund platforms by fund providers. It was taken out of the annual management charge, and so to many investors it was as if they were receiving a free service, or at least it made it very difficult to determine how much you were actually paying for the service.”

Commission was once commonplace for our industry but not for much longer. RDR followed a FSA review in 2006-2007 that sought to apply the principles of the Retail Distribution Review from guidelines initially set down by the then UK Dept of Trade and Industry and Trading Standards.

Pre RDR there were around 40,000 UK advisors in 2011; today less than 30,000. Morningstar notes investors have opted for DIY, fuelling popularity of ETFs, more focus on fees, both in terms of individual investors, DIY investing and professional investors investing on their behalf. There's also been a commensurate rise in the number of multi-manager, fund-of-funds and risk-rated launches to meet investor demand post-RDR. Many of which are Funds of ETFs or low cost index based. Disintermediation of packaged products and compressing value chains actually led to reintermediation and unbundling into complex value chains. Overall costs are coming down but only very slowly. Fee refraction rather than compression. Transparent perhaps but not immediately better or easier for fund investors. The biggest outcome of RDR has been the shift towards cost transparency, something I personally support. Yet along the way cost did become confused with value and perhaps explains the last tact taken by the UK regulator, the FCA.

The board of the Financial Conduct Authority (FCA) announced in May that it had accepted proposals to ditch the term 'value for money' from the final rules relating to the Asset Management Market Study (AMMS). Respected commentators like Graham Bentley noted this is repackaging was merely semantics. However if truly the case then why bother making a change at all? Was the result of lobbying, if so by whom or simply an attempt to clarify that value is not simply a divisor of cost? The minutes from the board meeting on 21-22 March showed proposals from the AMMS were discussed, including plans to tackle weak price competition. Concerns were expressed about some of the terminology used, particularly the use of the term ‘value for money', which will be removed from the final rules in favour of “whether the charges are justified in the context of the service and value provided”.

Professional fund investors are all too aware of the challenges of securing value for their investors, a culmination of selecting the right fund and accessing it at the right price. That’s a balance rather than binary question, which comes down to knowledge of the fund, the marketplace and investor needs. Investment consultants came under criticism on just this point; now subject to a fairly intrusive CMA investigation, whilst many fund buyers feel a broader pressure to race to the bottom to buy index funds rather than the more arduous task of arguing for value further up the fee scale to their investment committees. All the while independent governance types are challenging cost on a level never previously seen. Academics and SPIVA reports sledgehammer the industry that ‘outperformance persists but not continuously so’ and this drives a friction between activist groups like the Transparency Task Force (I am a member), pro index evidence based investors, pro active professional fund investors, non regulated consultants, research agencies, scheme trustees and fund managers alike. Messy.

However rather than becoming some gold-plated market caught in a fiduciary flytrap between the US reversing its DOL Fiduciary laws and the EU allowing local exemptions; the UK appears to have become the model to follow (for now). Brexit may change things. Meanwhile South Africa readies itself for its own RDR transformation, just as Europe adjusts to MiFID2. My fellow fund buyers should be ready that inducement rules, cost transparency, competition and value for money will quickly follow. Professional fund investors, whether in Cape Town or Copenhagen, must be ready to evidence value-add and value for money for the fund managers they select. That may drive a shift to higher conviction boutiques or conversely towards more scalable giants; consolidation, passives and supertankers alas are al symptoms of RDR to date. Time to pack the sun bloc.