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How to use value-for-money reports on your funds

Investors have chance to carefully analyse funds following the introduction of value-for-money reports
February 13, 2020

Deciding whether to invest in a fund should be easier than ever. Years of regulations, improving standards of transparency and the arrival of various types of investment tools mean that fund investors have access to a huge amount of information about their holdings. Data such as more detailed breakdowns of fees and charges, and extensive disclosure of past performance, volatility levels and managers' investment styles should make finding the best funds a straightforward task.

But in reality, the difficulty of quickly comparing large numbers of funds makes this much harder, as does the challenge of focusing on several different metrics. For example, while an active fund may charge much less than its sector peers it could tend to deliver less impressive returns.

A further complication is that the individual nature of each investor’s needs means that no one fund will suit everyone. For example, Legg Mason IF Japan Equity (GB00B8JYLC77) substantially outperformed its benchmark, the Topix index, and other Japanese equity funds over the past decade. While this fund may appeal to a growth-oriented investor, its high volatility over shorter time periods will not suit those needing more predictable returns.

So finding the best funds for your investment goal and scrutinising existing holdings remains a challenge.

However, investors now have a new piece of information with which to assess the merit of funds. Following a probe into competition in the asset management industry, the Financial Conduct Authority (FCA) issued rules that require fund providers to issue a report each year detailing whether their funds provide value for money. These reports assess whether a fund provides value for money against a “non-exhaustive list of prescribed elements”, including whether its charges are reasonable in relation to the costs incurred in running it. Because the report's timing relates to a fund's yearly financial reporting periods, value-for-money assessments should be released at different times throughout the year.

These reports can be sent directly to investors in the fund by the asset manager that runs it or a third party such as an investment platform, but there is no guarantee that this will happen. However, the reports must be made publicly available and investors can request them from fund providers.

While these reports should help you to decide which funds are best for you, you will still need to conduct careful analysis.

Some of the first of these value-for-money reports have been released by fund providers including Vanguard, which is best known for its passive funds. It has issued assessments for UK-domiciled passive funds including Vanguard FTSE 100 Index (GB00BD3RZ368), its LifeStrategy multi-asset range and active funds such as Vanguard Global Emerging Markets (GB00BZ82ZY13).

Rathbones has issued value-for-money assessments for funds with a reporting period that ends on 30 September or 31 October. These include Rathbone Ethical Bond (GB00B7FQJT36), Rathbone Income (GB00BHCQNL68) and equity fund Rathbone Global Alpha (GB00B8W5FR09).

These providers have focused on similar metrics. Vanguard assessed whether its funds provided good performance in relation to their investment objective, whether charges were fair in relation to the cost of the services delivered, whether the funds had appropriate economies of scale and whether these had been passed on to investors via fee reductions, plus how charges compared to those of similar funds. Vanguard also looked at whether investors of a similar size paid the same amount to invest in a fund, whether investors had invested in an expensive share class when a cheaper one was available, and whether investors were happy with the range and quality of service.

These reports should give an idea of how your funds stack up. Vanguard, for example, found that 93 per cent of the funds for which it issued value-for-money reports outperformed their peers over 12 months and that its funds' charges were, on average, 73 per cent cheaper than that of their fund sector average.

However, a more granular analysis shows where individual funds might struggle. For example, Vanguard Global Equity (GB00BZ82ZT69) and Vanguard Global Equity Income (GB00BZ82ZV81) failed to keep up with their benchmarks over one and three years but fared better against other funds.

 

What to look for

Using the reports to make your mind up on existing holdings or possible additions is not easy. Every investor has their own specific investment goals, so the selection of funds that is suitable for them may not suit other investors. And the FCA has not set a template for the reports, so fund providers can make the case that their products represent value for money in different ways, meaning the reports on different providers' funds may not be comparable with each other.

This makes sense in other respects. For example, assessing the value for money of an active fund is different to assessing that of a tracker fund, while active funds in the same sector can take very different approaches to each other.

But it means that asset managers are likely to focus on different things, depending on their own strengths, priorities and customer bases.

“There are passive providers saying that you bought the market and the market has done this,” says Graham Bentley, an investment consultant. “They may want to focus on their tracking error relative to the price. But if a provider charges 0.3 per cent for a passive fund that has less value than [a similar] one which charges 0.07 per cent. So if fund providers struggle to justify their fees they might focus on the research, their staff and the support materials they provide.”

Mr Bentley adds that fund providers are likely to evaluate the virtues of their investment approaches depending on what is topical in a given year and what might matter to investors with a certain asset class. In the wake of the Woodford scandal and the gating of M&G Property Portfolio (GB00B89X8P64) last year, for example, asset managers who run open-ended property funds may claim to provide value for money by holding large levels of cash and managing liquidity risk.

So it is worth assessing funds’ value-for-money reports versus those of comparable funds focused on the same assets. But, most importantly, you should judge existing holdings against your original rationale for buying in.

“What were you led to believe and has that been delivered?” says Mr Bentley. “If you had invested in LF Woodford Equity Income you might not have expected to have [exposure to] unquoted stocks.”

As value-for-money assessments are likely to evolve over time and each one only covers a 12-month period you should check as many as you can. Third parties such as investment platforms may also provide their own assessment on whether funds provide value for money.

 

Improvements ahead

Value-for-money disclosures are a potentially useful new source of information, but could also result in some disruption for investors. The FCA’s disclosure requirements will lead to heavier scrutiny of funds that appear to overcharge investors or fail to deliver on their stated objectives, and this may prompt asset managers to rethink what they offer. The FCA also requires asset managers to “take corrective action" on funds that do not provide this. This could result in investors that hold funds' older, more expensive share classes being moved into cheaper ones – if they are available. Fund charges that seem high could be reduced and funds that levy performance fees, as is the case with a number of targeted absolute return ones, may struggle to justify them.

“I think performance fees will disappear fairly quickly,” says Mr Bentley. He adds that in some cases you might get a choice of what you invest in, for example between a share class that charges a higher base fee but doesn't have a performance fee and a share class with a lower base fee but a performance fee on top of it.

At the start of this year Columbia Threadneedle ditched performance fees on some of its long/short equity funds, including Threadneedle UK Absolute Alpha (GB00B8BX5538) and Threadneedle American Extended Alpha (GB00B28BBW75), although the company did not say that this was due to the introduction of the value-for-money reports. Columbia Threadneedle said it had decided to stop levying performance fees as part of its commitment to ensure its fees are “fair, simple and transparent".

Elsewhere, more drastic action may follow if funds do not perform well. Rathbones' reported that its Global Alpha fund, which is run for a single institution, performed poorly. Although Rathbones concluded that the fund still represents good value, the recent scrutiny may result in the fund's closure.

"This fund was set up solely for a third party to distribute to its clients, with the investment policy, objective and benchmark agreed at launch," said Rathbones' report. "The third party is the sole unit-holder of this fund. We proposed redesigning this fund’s investment policy to invest directly in shares and bonds, as we believe this gives the best outcome for investors, reducing costs and giving us more control over the risk in our portfolio. Further to our proposal, the third party informed us that they would instead be redeeming their investment in this fund. Subject to FCA approval, we will be closing this fund in 2020."

Devin McCune, vice president for regulatory and compliance at Broadridge Financial Solutions, believes that fund closures could become more common. “We may see greater oversight of investments and adjustments to a fund’s investment policy as an initial step to improve value for underperforming funds,” he explains. “In the longer term we may see changes in portfolio management teams if funds struggle to perform. A final step may be the closure of funds that are underperforming, especially those that are not at scale.”

At a time of rising operating costs for asset managers, smaller funds are generally at a greater risk of being closed or merged into another product. The chart below, based on Refinitiv data, shows that at least 100 UK domiciled open-ended funds and exchange-traded funds (ETFs) were closed or merged away in each year of the past decade.

Separate data provided by Refinitiv to Investors Chronicle suggests that many funds struggle to attract investors' money – even after they have established a three-year track record. Nearly a quarter of the 2,305 UK-domiciled funds with a track record of three years or longer at the end of 2019 had assets worth less than £50m.

This could mean that many small funds are closed or merged into bigger funds which, though disruptive in the short term, could ultimately be beneficial. But small outperforming funds, some of which we highlighted in September, could continue to exist. Mr Bentley believes that funds such as MFM Bowland (GB0008265307), which has assets worth around £20m but significantly beats the returns of other UK equity funds, should survive. But he thinks that there might be a reduction in numbers of 'fashionable' funds focused on areas such as technology or which invest via an environmental, social, and governance approach.