The recent FCA interim report on its market study of the asset management industry has sent vast reverberations through the fund research and investment consulting industry. For the first time fund rating agencies, DC consultants and centralised fund selection teams will be scrutinised on their processes, objectivity, approach to buying passive funds, business alignment and fund governance. In my book '#newfundorder' I talked about the lurking dangers for active fund selection, not simply from the advent of digitalisation but also the complacency of the fund research community and whether fund raters themselves should be rated.
The premise of the study is that poor levels of competition within asset management exist and that one factor may be issues relating to the recommendation of fund managers. Tucked into Chapter 8 the indications from the FCA document should be a matter of concern for all professional fund investors.
"Based on our analysis, on average investment consultants are not able to identify managers that outperform compared to non-highly rated managers." P151, Ch8, MS15/2.2, 'Asset Management Market Study'
Why do we find ourselves at the end of a very large fiduciary sword? Professional fund investors have historically failed to tackle issues that were building momentum such as asset concentration, star manager culture, market expansion, consolidation, costs, fund proliferation and persistent underperformance and most importantly the stark absence of empirical evidence supporting professional fund investing. These issues are rapidly coming home both in the US through the Fiduciary DOL rule and the UK and Europe through Retail Distribution Reviews and a series of fiduciary-themed regulation.
In short fund selectors have operated within silos, have been poor at sharing information and thus once isolated find themselves under both consumer and regulatory pressure.
The solutions are five-fold:
- Demonstrating the excess returns generated by selecting active fund managers
- Sharing best fund ideas and research with other fund buyers
- Standardising due diligence questionnaires and identifying best practice
- Tracking the performance of fund selection through independent verification
- Proving transparent evidence of cost savings and adding economic value
In other words operating as an effective community and benefitting from the wisdom of the crowd. In his book, 'The Wisdom of Crowds: Why the Many are Smarter than the Few' by James Surowiecki
"Capturing the ‘collective’ wisdom best solves cognitive problems. Four conditions apply. There must be: (a) true diversity of opinions; (b) independence of opinion (so there is no correlation between them); (c) decentralisation of experience; (d) suitable mechanisms of aggregation."
Surowiecki asserts that ‘Collective wisdom’ is put to good use to tackle three kinds of problems, and that complexity is no barrier;
Cognition problems: such problems arise when we can only guess the answer – as e.g. about the contents of the jelly bean jar, or about the future. How do we get the guess right?
Coordination problems: how to we coordinate behaviour with each other – say in traffic – knowing that everyone else is trying to do the same?
Cooperation problems: how do we get self-interested, distrustful people to work together, even when narrow self-interest would seem to dictate that no individual should take part – as in politics
The changing regulatory landscape is putting increasing pressure on professional fund investors and consultants. There is no reason that fund research cannot be a mechanism of aggregation, a crowd. It can help the fund research community work together, demonstrate value and identify better fund managers by sharing insights. SharingAlpha is the first and only collective fund rating platform (globally) that provides fund buyers the opportunity to track their performance independently and share insights. Adam Smith’s ‘invisible hand’ explained how aggregation allows competition and adds value, and fund buyers can provide evidence to address the ever steepening compliance journey.
Hopefully see you in the cloud; perhaps see you on SharingAlpha.