PwC Perspectives on Industry Practices Fund Profitability

Transcription

1 PwC Perspectives on Industry Practices Fund Profitability Mutual Fund Directors Forum Fort Myers, Florida January PwC

2 PwC Perspectives on Industry Practices Fund Profitability Current Environment Directors Consideration of Fund Profitability Illustrative Advisory Contract Renewal Approach Form and Content of Fund Profitability Presentations Process Methodology Reporting and Disclosure Closing Thoughts

3 Current Environment Heightened level of interest in understanding fund profitability process relative to industry practices Media Attention The investment industry and wider financial press continue to publish articles and commentary questioning the amount and transparency of fees charged by advisors. Regulatory Environment SEC s Office of Compliance Inspections and Examinations communicated Boards also did not drill down far enough in their consideration of the advisor s profitability and how it relates to other entities. (Board IQ, March 14, 2006). Recent disclosure requirements of the factors considered in connection with the advisory contract renewal process has focused directors attention on understanding not only fund expenses, but also the investment adviser's expenses to service the funds.

4 Current Environment, continued Heightened level of interest in understanding fund profitability process relative to industry practices Litigation Over the last several years there has been ongoing litigation alleging excessive fees charged to mutual fund shareholders. The plaintiff needs to demonstrate that the advisor charged a fee that is so disproportionately large that it bears no relationship to the services rendered and could not have been the product of arms-length bargaining (Gartenberg v. Merrill Lynch Asset Management 1982). Growing Complexity of Business Models Level of complexity in determining profitability can vary among firms a global financial services firm with multiple lines of business and product offerings is challenged by isolating the profitability data for mutual funds only further complicated if the information is not otherwise used for internal management decisions Evolution of product offerings have introduced further complexity e.g. alternative investment products (hedge funds), fund of funds, wrap products, multi-class and closed end funds and sub-advisory relationships.

5 Directors Consideration of Fund Profitability Legal counsel plays an important role in advising the trustees on the advisory contract renewal process, information requirements and relative board consideration The directors and advisers responsibilities are guided by law, including Sections 15(c) and 36(b) of the 1940 Act Guidance provided from past court cases (e.g. Gartenberg) Emphasis on regulatory requirements and external forces Profitability information should be responsive to legal and business perspectives

6 Illustrative Advisory Contract Renewal Approach* DIRECTORS CONSIDERATIONS SERVICES PROVIDED BY ADVISOR/AFFILATES Investment Management SERVICES Sales & Distribution Fund Administration & Fund Accounting Nature, extent and quality of services Benchmarking of fund fees (expense ratios) Advisor profitability Transfer Agency and Shareholder Services MANAGEMENT INFORMATION AND ANALYSIS Economies of scale Other costs and benefits to the adviser and its affiliates arising from the fund relationship Fund Profitability Process Methodologies Reporting and disclosure *Framework shown is not intended to convey a legal standard.

7 Form and Content of Fund Profitability Presentations Information provided should be in a form and contain content sufficient for directors to understand costs of services provided and profits realized Measurement Challenges There are no generally accepted accounting principles (GAAP) or similar set of standards; consequently, presentation of data to boards does not follow a proscribed, standardized format or scope. Many organizations use an ad-hoc process to develop and compile their adviser profitability data used in connection with the 15(c) contract renewal process. The information generally is not used in managing the business. A few organizations, however, have developed an integrated financial reporting model that leverages technology and information used to make business decisions. Consideration should be given to whether the profitability data is responsive to the economic measures that the advisor uses to manage its business. Other points for consideration related to process, methodologies and reporting and disclosure are referred to herein.

8 Process Develop a process to (i) capture and maintain financial data, (ii) assess ongoing methodologies with business practices and (iii) present financial analyses and disclosures that are meaningful to the board Information used in managing business Changes in business and organization Internal and external resources Documentation practices Continuous improvement

9 Methodologies Allocation methodologies incorporate many judgments and the objective is to produce a reasonable estimate of the economic resources generated or consumed through a series of business activities. Business complexity Document and review methodologies Balance consistency with changes that are responsive to the business Correlation of cost drivers and business activities Extent of use in business Consistency with other disclosures Special considerations

10 Reporting and Disclosure While there is diversity in practice, profitability information provided should be in a form sufficient for directors to understand costs of services provided and profits realized and contain adequate disclosures Level of reporting and nature of activities included Consistency with other disclosures and internal information Trends over multiple reporting periods Analysis Internal and external comparisons Management discussions and analysis Basis points With and without convention Supplemental disclosures and analyses should be considered Structure of compensation programs Fall-out benefits Economies of scale

11 Reporting and Disclosure Considerations Illustration: Profitability Business Overview Average Assets Revenue: Investment Management Fees Sales Commissions 12b-1 Fees Fund Accounting Fees Transfer Agent Fees Other Fees Total Revenue Expense Investment Management: Portfolio Management Research and Trading Adminstration Subtotal Investment Management Sales and Distribution Promotion and Advertising Sales & Commissions Investor/Call Centers Administration Subtotal Sales and Distribution Back Office: Transfer Agent Fund Accounting Subtotal Back Office Total Expenses Pretax Income Pretax Margin After-Tax Margin % Change % Change

12 Reporting and Disclosure Considerations Illustration: Profitability by Functional Category FUNCTIONAL COMPONENTS Investment Mgt. Sales & Distribution Back Office Total g Revenue: Investment Management Fees Sales Commissions 12b-1 Fees Fund Accounting Fees Transfer Agent Fees Other Fees Total Revenue Expense Investment Management: Portfolio Management Research and Trading Adminstration Subtotal Investment Management Sales and Distribution Promotion and Advertising Sales & Commissions Investor/Call Centers Administration Subtotal Sales and Distribution Back Office: Transfer Agent and Shareholder Services Fund Accounting Subtotal Back Office Total Expenses Pretax Income Pretax Margin

13 Closing Thoughts Set a tone for a dynamic rather than static environment supporting the preparation and presentation of advisor profitability that is responsive to changes in the business. Profitability is one of several factors pertinent to the advisory contract renewal process and each factor should be given a relative weighting by trustees using their business judgment. In the absence of any financial analyses in evaluating economies of scale, the directors, at a minimum should consider this matter from a qualitative perspective eg breakpoint pricing, expense reimbursements, fee waivers and reinvestments in the business. Cost allocation methodologies incorporate many judgments and the amounts determined are, by their nature, estimates The use of different methodologies may produce different results.

14 John Griffin PricewaterhouseCoopers LLP 125 High Street Boston, MA (617) John Griffin is an Assurance/Business Advisory Services (ABAS) partner, resident in the Boston office, in the Investment Management industry practice. He has over 20 years experience specializing in the investment management industry. John is one of the firm s subject matter specialists who leads our practice that advises our investment management clients on 15 (c) matters, including mutual fund profitability and reporting. He has also been involved in due diligence reviews in connection with acquisitions of investment advisors. John has provided audit and other assurance and business advisory services to a number of global financial services clients. John received his B.S. in accounting from Bentley College. He is a member of the American Institute of CPAs and the Massachusetts Society of CPAs PricewaterhouseCoopers LLP. All rights reserved. "PricewaterhouseCoopers" refers to PricewaterhouseCoopers LLP (a Delaware limited liability partnership) or, as the context requires, other member firms of PricewaterhouseCoopers International Ltd., each of which is a separate and independent legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers LLP. PwC