IMA CONSULTATION POST-RDR IDENTIFICATION OF THE PRIMARY SHARE CLASS BY THE DATA VENDORS IN PREPARATION OF PERFORMANCE DATA

Transcription

1 IMA CONSULTATION POST-RDR IDENTIFICATION OF THE PRIMARY SHARE CLASS BY THE DATA VENDORS IN PREPARATION OF PERFORMANCE DATA June 2014

2 1 POST-RDR IDENTIFICATION OF THE PRIMARY SHARE CLASS BY THE DATA VENDORS IN PREPARATION OF PERFORMANCE DATA CONSULTATION There are over 3,000 investment funds on sale in the UK. The IMA s sectors provide a way of dividing similar funds into smaller, more manageable groups to allow investors and financial advisers to compare funds in one or more sectors before looking in detail at individual funds and making their investment decisions. 1 Data vendors collect performance data which is provided in ranking tables to allow performance comparisons across similar funds. They also calculate average performance data for the overall sector. Historically the data vendors have identified a primary share class from each fund to use in the presentation and calculation of performance data. This has typically been the highest charging retail share class so that investors are presented with the worst case scenario in term of possible returns. However it was clear that following the Retail Distribution Review (RDR), this relatively straightforward approach would have to be revisited. In 2012, the IMA issued a paper setting out two central elements: 1. New RDR share classes should take the track record of pre-rdr commission loaded 2 retail share classes, unadjusted for the lower fees of the new post RDR share classes. This would ensure that investors could see the performance actually achieved as opposed to a theoretical outcome. 2. Data vendors should retain the existing calculation methodology for IMA sector averages using the highest charging commission loaded retail share class as the primary share class until such time as a fuller view could be taken about the future direction in a post-rdr environment. This paper represents the next steps in this process. Feedback from this IMA consultation is intended to help the industry come to a conclusion that can be consistently applied by all data vendors that collect performance data for IMA sectors. The paper is in three parts: 1. Summary of the proposals that the IMA would like to be considered. 2. Detailed background. 3. Summary of pros and cons of the various options available. 1 For more information on the IMA sectors, see: 2 Before new Retail Distribution Review rules came into force, most retail share classes had an annual management charge that included amounts to pay trail commission to advisers and payments to platform service providers we have used the term commission loaded or pre RDR to describe these share classes. In the post RDR world, most new sales are made in share classes which have removed the amounts for adviser and platform payments. There are some on-going sales in commission loaded share classes, for example in regular savings plans where no additional advice has been received since 1 January 2013.

3 2 There is also an annex which has been provided by the main data vendors, which proposes the main business rules that will apply when identifying the primary share class. The consultation is a public one and we encourage feedback from all users of the sectors to express a view. Comments should be sent to Nicola Kembey Head of Sectors at nkembey@investmentuk.org or Richard Mawson at rmawson@investmentuk.org by close of business Friday 29 August 2014.

4 3 PART ONE: Summary of the proposals 1. Data vendors to adopt a primary post-rdr share class by an agreed deadline. Current thinking would favour 1 Jan 2015 given all the practical issues that need to be overcome in extending track records. The change would be implemented for the ranking tables and the sector averages on the same date. 2. A post-rdr share class to be identified by the data vendors through a set of business rules defined as a share class which includes all the elements included in the on-going charges figure required by the Key Investor Information Document, but no trail commission or platform payments. 3. To consider two options: a) Option A to replace the existing commission loaded primary share class with the highest charging post-rdr share class. This would retain the historic approach in the identification of the primary share class in that it would reflect the highest charging share class under the new regime. In that respect it is the most cautious approach. It could, however, represent the experience of a minority of investors, notably where firms retain a higher charging share class for those that choose to access funds directly (as this would be the new primary). b) Option B to replace the existing commission loaded share class with the post-rdr share class that represents the highest charging share class distributed via a fund platform. This would reflect the fact that the majority of retail distribution takes place through platforms. Share Classes Cost of operating fund Includes Adviser Commission Platform payment Who will typically own/buy these classes? Legacy 'Commisssion Loaded' share class (Current Primary) Yes Yes Yes Legacy shareholders and those in regular savings schemes that have not received advice after 1 Jan 2013 Most expensive post RDR share class (Proposed Primary Option A) Yes No No Investors who buy direct from a manager if the highest charging post RDR share class is a direct share class Most expensive platformdistributed post RDR share class (Proposed Primary Option B) Yes No No Investors who buy through a platform Option B creates practical problems for the data vendors as identification of the share class cannot be fully automated by a set of business rules. In order to capture this information the data vendors would use the highest charging post-rdr share class as the starting point. For some that would automatically equate to the share class typically distributed via fund platforms. For others there could be a higher charging share class which includes an amount to cover internal distribution or administration either as a result of a vertical distribution model (e.g. banks) or where retention of a share class for direct investors has been provided. In order to create a level playing field for performance comparisons, the data vendors have suggested that the most practical solution would be to allow managers who have post-rdr share classes which include in their fees an amount for internal distribution or administration to

5 4 provide a signed document from their compliance team asking for exclusion of these share classes from the selection process. In this approach, the onus would be on the manager to provide this information to all the data vendors otherwise all post-rdr share classes would remain eligible and the highest charging RDR share class would be selected. While it has been suggested that the IMA could act as a central data repository for the collection of post-rdr share classes identified as the primary share class, the IMA does not feel that its role extends into this area. It believes that the historical role that the Association has played, focused primarily on the definition of the sectors, is the correct one. 4. The data vendors to extend track records to post-rdr share classes on agreement with the manager using the existing highest charging commission loaded retail share class. The track record from the donor share class will not be simulated to adjust for the RDR share class fees. Specific questions: 1. Do you think that that Option A or Option B is the best solution? 2. If you believe that Option B is the most appropriate solution, do you believe that there should be a mechanism to exclude share classes that are not designed for platform distribution? 3. Do you see any difficulty arising now or in the future from the fact that performance data provided in the KIID may not be consistent with the data displayed in the ranking tables? 4. Do you agree with the time period suggested? 5. Any other comments?

6 5 PART TWO: Consultation background The introduction of the RDR has presented a challenge for the presentation of fund performance data. Performance data is supplied by the managers of authorised funds to the data vendors who in turn provide ranking tables and create sector averages which are based on a primary share class for funds in IMA sectors. The primary share class has historically been the highest charging retail share class and has been identified based on a set of arm s length business rules. Data vendors would like to maintain this arm s length business rules approach. In the absence of regulatory guidance and a consistent data vendor policy, the IMA s paper in December 2012 considered how best to maintain consistency and comparability of relevant performance data following RDR. It noted that each solution for changing the primary share class had its imperfections as the pre- and post-rdr worlds are different and investor experience overlaps the two. The original guidance can be found here: The post-rdr environment is, however, changing quickly and the IMA is conscious of the need to update the position as the market evolves: The majority of investors (and assets in funds) in January 2013 were in commission loaded (pre-rdr) share classes and as a result it was reasonable to assume that they wanted to compare the performance of a commission loaded share class with a similar share class or average. In January 2014, IMA analysis showed that 62% of gross retail sales and 39% of assets had shifted into post-rdr share classes. This supports requests to review which primary share class is used. The difficulty is providing comparisons for both investors in commission loaded share classes and new investors in commission free share classes. Both have a reasonable expectation to compare their funds. Given the proliferation of share classes, it has become increasingly difficult for the data vendors to identify which one to use so that retail investors can make reasonable comparisons. Options considered in choosing the new primary share class A consumer has a reasonable desire to be able to compare funds on a like for like basis. They also might reasonably expect the data in the ranking tables to represent their performance experience. It may be difficult to reconcile the two. The IMA Sectors Committee considered a range options as to the primary share class in the post RDR world that would be most helpful to users of the sectors; each had its own pros and cons, and these are set out in more detail in Part Three: the highest charging post-rdr share class the most widely-sold post-rdr share class the lowest charging post-rdr share class a manager nominated post-rdr share class a share class that would show the gross performance of the fund and thus manager skill i.e. before any manager or distribution costs a composite share class either equal or money weighted for all the share classes available in the fund

7 6 As a result of its deliberations, the Sectors Committee considered the highest charging post RDR (commission free) retail share class to be consistent with the historic approach of identifying the most cautious approach. In this respect, there was initially an expectation that in the post-rdr environment there would be convergence around a commission free platform share class as the highest charging share class. However, analysis of data showed some unexpected results. A broad spectrum of share classes was reported as RDR compliant. For some firms, the highest charging post-rdr share class is the platform share class, but for others there seems to be a higher charging post-rdr share class as a result of a vertical distribution model (banks) or where retention of a share class for direct investors has been provided (and additional administration costs are incurred). Some funds have this share class as well as platform share classes. Others do not. Given that IMA data suggests that most consumers may access a fund through a post-rdr share class sold on a platform, a consequent concern was that the highest charging RDR share class may not in fact reflect the actual experience of most investors. Therefore, the Committee s view was that an approach could be developed which tried to harmonise around a predominant freely available share class that, in the current sales environment, is the platform share class. Data vendor considerations While the needs of consumers are the key priority, the practicalities of different options for data vendors also had to be considered. The data vendors need to have an independent internal process to identify a post-rdr primary share class by application of a set of business rules, as in current practice. Using the highest charging post-rdr share class would allow this identification to take place based on existing data supplied to the data vendors. However, a platform share class may be difficult for the data vendors to identify in this way. It may require further data or evidence to allow the vendors to select it correctly which complicates the process. The data vendors believe that the most practical solution is to allow managers who have post-rdr share classes which include in their fees an amount for internal distribution or administration to provide a signed document from their compliance team which identifies the share classes which should be exempt from the primary share class selection process based on inclusion of this internal distribution cost. The onus is on the manager to provide this request to all the data vendors otherwise the highest charging RDR share class will remain as primary. By eliminating those share classes from the calculation, it is hoped that a level playing field will be created around those share classes that are distributed through a platform. While it has been suggested that the IMA could act as a central data repository for the collection of post-rdr share classes identified as the primary share class, the IMA does not feel that its role extends into this area. It believes that the historical role that the Association has played, focused primarily on the definition of the sectors, is the correct one. Practical implications of changing the primary share class: The data vendors typically use the primary share class in two main ways:

8 7 1. To show the performance of individual funds within the performance ranking tables. 2. To calculate a sector average index. Ranking tables The vendors have noted a number of problems that will impact on the individual fund data in the ranking tables in the event of a change in the primary share class. These can be summarised as follows: 1. There are a high number of post-rdr share classes where the manager has chosen not to extend a track record yet or at all. In addition some managers have specifically chosen not to attach the track record of the existing primary share class because they feel it is not relevant or misleading. This will lead to inconsistency of approach particularly over longer time periods. 2. Different vendors have taken a different approach to attaching performance histories in different data products. Some have extended track records automatically, others have not. 3. A number of firms have converted a pre-rdr share class to their post-rdr share class which will impact on their individual long term track records carried in the tables, particularly where an institutional share class has been converted to the post-rdr share class. However the historic sector average indices would not be affected. It also appears that in some cases the performance data in the KIID has been extended based on internally calculated synthetic track records. So the data in the ranking tables may not reconcile with the regulatory literature. Sector averages Sector averages are calculated in different ways, both as indices and as simple averages. Indices The data vendors various methodologies for calculation of IMA sector averages have been in place over an extended period of time. As a result the data vendors have created a long time series of data based on these index calculations. Their methodologies do not change the past performance history of the IMA sector averages once it is created; this eliminates survivorship bias issues. Their current methodologies are based on using the highest charging commission loaded retail share class as the primary share class the most cautious approach. The existing IMA sector average indices therefore have a long times series of data attached to them which is valuable and the IMA feels it should not be distorted without good reason, or lost. Therefore the intention is for the data vendors to link together the performance data of the sector average indices based on the post-rdr primary share classes to the pre-rdr data series at an agreed point in time. Changes to the primary share class for individual funds and the sector averages would take place simultaneously. Consideration was given to running a number of data series in parallel using different primary share classes but it was decided that this could cause confusion.

9 8 Simple sector averages The IMA is aware that sometimes sector averages are computed by taking the simple average of the performance data provided on individual funds in the ranking tables. This data will be different to the data computed in the sector average indices. The sector average indices will use the highest charging pre-rdr share class as primary until [1 Jan 2015] when the primary share class will be changed to an agreed post-rdr share class. For individual funds the track record of the post-rdr share class will be available from the launch date of the share class and track records based on the highest charging pre-rdr share classes will be extended back from that date. Therefore taking a simple average of data in the performance tables may be distorted owing to the different launch dates of post-rdr share classes. Changing the primary share class will require at least 3 months lead time to allow the data vendors to apply the change consistently. In order to allow time to for further liaison with firms on track record extensions, it is probable that 1 January 2015 will be adopted as the most sensible date for implementation.

10 9 PART THREE: Different Options considered by the Sectors Committee Option 1: Highest charging RDR share class PROS i. Worst possible performance that a new retail investor could experience most cautious approach overall ii. Easy for data vendors to identify at arm s length CONS i. May reflect the experience of a minority of investors Option 2: Most widely sold RDR retail share class PROS i. Reflects the performance of most investors? CONS i. Difficult for data vendors to identify at arm s length without collecting further data. ii. Risk that the most widely sold share class could change over time causing confusion over which share class to use as the primary. So not future proofed. iii. A level playing field would not be available for direct or vertically-integrated business models Option 3: Lowest charging RDR share class PROS i. May incentivize investors to look for the best deal if this is not their experience ii. Easy for data vendors to identify at arm s length CONS i. Manager may be happier than the consumer in use of this share class as primary ii. May not be the investor experience when distribution costs are added Option 4: A manager nominated RDR retail share class PROS i. Clear cut for the data vendors CONS i. Who acts as repository for the information? ii. Does it require evidence to support the nomination? iii. Manager bias? Option 5: Gross of charges This option considered stripping out fees from the performance data. PROS

11 10 i. Shows manager skills ii. Allows for consistent comparisons in the ranking tables CONS i. Operational issues - Gross returns are not normally available via the NAV based accounting platform. GAVs can be calculated but these aren t true gross total returns. The NAV based accounting platforms tend to be on a settled basis whereas total gross returns are calculated on a traded basis. ii. Consumer cannot experience this performance iii. Regulator requires past performance to be disclosed net of charges: COBS A firm must ensure that information that contains an indication of past performance of relevant business, a relevant investment or a financial index, satisfies the following conditions: #6.if the indication is based on gross performance, the effect of commissions, fees or other charges is disclosed. Option 6: Composite adopt a GIPS composite calculation methodology (AUM/equal weighted average returns) PROS i. Includes all share classes ii. Would provide a standard consistent with those adopted for institutional clients CONS i. No one has experienced this performance ii. Concerns about imposing more rules on managers iii. Institutional share class bias iv. While this isn t difficult for a manager who has adopted GIPS for institutional sales, the data vendors are unlikely to have the capability to easily switch this on.

12 11 Annex: provided by data vendors Draft methodology for primary share class selection for IMA The following outlines the approach that will be taken to identify the primary share class in IMA sectors by a number of vendors 3. The primary share class is the one that is generally used as a proxy for the fund in performance tables and comparisons. It is hoped that other data vendors who use the IMA sector classification system will also adopt this approach in order to promote consistency. Following the implementation of the retail distribution review IFAs and fund platforms cannot offer to their clients any share classes where the fund group pays them a distribution fee or trail commission, although any existing holdings in such share classes can still be held. Share classes that do not pay a trail commission /distribution fees are commonly called clean share classes and, due to the change, it is considered that the highest charging clean share class would be the most appropriate primary share class. The detailed primary selection criteria are explained below and will be applied by a process of strictly sequential elimination, until only one share class per fund remains, which will then be chosen as the primary. If more than one share class meets any criteria (e.g. more than one share class shares the highest on-going charge) then all those share classes matching the selected preference will be judged using the next criteria, with any share classes that do not match the first test being discarded. If no share classes for the fund match a criteria then none of the share classes should be discarded and all remaining share classes will move on to the next criteria. To be considered as a primary share classes, for the purposes of IMA sectors, the share class must be:- 1) Available for sale in the UK (Ensuring that the share class has UK reporting status) 2) Active; Of the share classes that meet the above criteria take the share class that:- 1) Does not include any trail commission or external distribution fees; 2) Does not include any administration costs associated with the direct distribution of the share class to end investors*; 3) Has the highest on-going charge; 4) Has the highest maximum annual management charge; 5) Is currency hedged into Sterling; 6) Has a share class currency of Sterling; 7) Is an accumulation share class; 8) First alphabetically; 3 To be confirmed

13 12 Share class types 1) Legacy/Bundled Fee The share class charges an annual management fee and distribution fee. 2) Clean/Unbundled Fee The share class charges an annual management fee but no distribution fee or trail commission is charged by the fund group as part of its fee structure. 3) Negotiated Fee These share classes do not have standard fees and any fees associated with the share class are negotiated on a client by client basis. *Note: Where a fund group has share classes that include a fee in the annual management charge to cover the administration of the distribution of the share class to end investors, due to the share class not being sold via intermediaries, then that share class will not be selected as the primary, unless the fund has no share classes that do not charge an internal distribution fee. It is the responsibility of the relevant fund group to identify these share classes to the data vendors, with their compliance department signing off that the share class is not sold via intermediaries and the annual management charge does include some distribution costs. Draft methodology for the extension of performance history (track) records The following outlines the approach that will be taken to apply the performance track record extensions to newly launched clean share classes of existing funds in IMA sectors by a number of vendors. Following the implementation of the retail distribution review IFAs and fund platforms cannot offer to their clients any share classes where the fund group pays them a distribution fee or trail commission, although any existing holdings in such share classes can still be held. As a result of this many groups have launched new, cheaper, share classes that do not contain these fees, often referred to as clean share classes. As these share classes will typically lack a significant length of performance track record, it is believed that there is a benefit to retail investors in allowing the performance history of these share class to be extended by using the performance of one of the older share classes of that fund with specific limitations on when and how an extension will be made. These extended performance track records will serve as the basis for performance calculations and peer group comparisons. The goal of this methodology is to give the most relevant information to retail investors, ensuring that any extended performance data is appropriate and representative of the performance a retail investor could have expected if the share class was launched earlier. This methodology will be uniformly adopted by the data vendors in the footnote, and any other data vendors who use the IMA sector classification system are encouraged to follow the methodology. The aim is to achieve greater consistency amongst the data vendors.

14 13 Any performance track record extension will have to adhere to the rules outlined below:- i) Any extension will use the highest charging existing retail share class. This share class would have had the lowest historical performance of the available share classes of the fund due to its higher fees and therefore can be seen as the most cautious scenario; ii) The performance track record from the chosen donor share class will not be amended/ simulated to adjust for the lower on-going fees of the clean share class; iii) Performance track record extensions are not possible between share classes that have a different currency hedging policy; For more details please refer to the individual data vendors stated policies on performance track record extensions.