ASSET MANAGEMENT Becky Young Competition Division Financial Conduct Authority 25 The North Colonnade London, E14 5HS 20 February 2017 Dear Becky ROYAL LONDON S RESPONSE TO THE FCA ASSET MANAGEMENT MARKET STUDY (MS15/2.2) Executive Summary Royal London Asset Management (RLAM) is pleased to submit our thoughts to you on the FCA Asset Management Market Study and hope that this helps with the FCA s decisions and outcomes from the study. As a business unit of the Royal London, the UK s largest mutual insurance company, we have a particular focus on member and customer care, as our members are ultimately our owners. This means that we are not focused on today s share price and are able to take a long term view to benefit our customers. We believe that your interim report presents some positive concepts which can help us as an industry deliver the best outcomes for customers. In presenting our response, we have approached it from the customer perspective. We believe that an industry-wide and collaborative approach will achieve the best outcome and best value for all of our customers. Over the past ten+ years the industry has become more intermediated with platforms, advisory firms and other distribution channels between us as asset managers and the end direct customer interactions. Therefore, many of the suggested approaches will help to enhance very important communication with and for customers. We believe that there are many good practices in the industry and that many of these can be enhanced to improve customer outcomes. However, we agree that there are other areas highlighted in the Market Study which may benefit from further changes. We have structured our feedback into four sections: 1
1. Fund Governance - RLAM agrees with the FCA s focus on the importance of governance and oversight and that strong governance can help to ensure that we deliver the best value and outcomes for customers. We believe that the current governance structure with enhanced clarification of duties, combined with the stronger requirements under MIFID2 and SMR delivers this objective. We do not believe that independent directors or additional governance bodies will help us to more effectively deliver value to customers. 2. Fund Fee Structures - We agree that all investors should understand the costs associated with investing in financial markets and that improved communication can help to enhance their understanding. We believe that including transactions costs within this figure will drive unintended negative consequences and that these should not be incorporated. Therefore, we support option B in which the OCF becomes the single charge, with additional disclosures of transaction charges. The investment management fees and charges are only one component of the total cost of ownership; it doesn t include the costs associated with distribution or investment advice these costs can be as much as or more than the total cost of investment management. We note with interest and are fully supportive of the FCA s proposal to undertake some further work on retail distribution as we feel that the topic of costs to investors should be considered holistically including both the manufacturing and the distribution of products. 3. Communications and Disclosure - We fully support the delivery of clear and fully transparent communications and disclosures to customers about their investments. It is important that investments deliver as expected by customers. We believe that adding detail and potentially complexity to fund descriptions, such as benchmarks in fund objectives, will not benefit customers in our experience most end customers are looking for outcomes, such as to pay a regular income. 4. The Value of Active Management We believe that both active and passive investment management are important components of the industry. While passive management may lower costs, it does not automatically produce the better outcome for customers. In providing our comments we have also incorporated feedback and input from across the Royal London Group, in particular from the pensions division where their recent experiences of both governance and costs/charges can inform views of the customer impact and customer benefits to specific solutions. It is important to recognise that the industry is currently in the midst of some wide ranging and complex regulatory implementation, including MIFID2, PRIIPS, SMR, as well as planning for appropriate responses to Brexit. This regulatory change is expensive and time/resource intensive to implement, all of which impacts on customers. Therefore, any changes/remedies agreed from this Market Study should be made in the perspective of positive outcomes already included in this regulation and not require multiple rounds or iterations of change. About Royal London Asset Management and our Customers Royal London Asset Management (RLAM) was established in 1988 and is one of the UK s leading investment companies. RLAM is a wholly-owned subsidiary of the Royal London Group. The Royal London Group consists of the Royal London Mutual Insurance Society Limited (RLMIS) and its subsidiaries, and is the UK s largest 2 P AGE
mutual life insurer. Founded in 1861, initially as a Friendly Society, Royal London became a mutual life insurance company in 1908. Being a mutual society, Royal London Group (the Group) is owned by its policy holders. As a member-owned organisation, the Group is fully committed to achieving long-term value for our members including providing excellent products, customer service and value for money. The Group s Board has expressed a long-term commitment to mutuality. RLAM has primarily focused on providing asset management services to UK clients with all staff being UK based. We offer a broad range of investment strategies across a range of core asset classes including, but not limited to; cash, equities, fixed income, property and absolute return. Within our broad range of equity and fixed income strategies we also offer funds managed using an ethical or sustainable approach. As at the end of December 2016, RLAM managed 103 billion in assets. In addition to RLAM, the RL Group also includes Royal London Intermediary Pensions division which is one of the UK s leading pension providers. We have included feedback from them in regards to those aspects which can inform our response. Our customers include a range of both retail, advised and institutional clients. As shown in the below diagram 1, these customers benefit from the oversight of their investments from a range of experts. Royal London Asset Management (1) OEIC/Unit Trust funds - 36bn Customers are ususally advised by IFA or other adviser; Oversight by fund company Board and by Depositary/Trustee Royal London Pensions - 25bn (2) Unit Linked funds; end customers in Defined Contribution schemes Oversight by IGC (Independent Governance Committee) Other RL Unit Linked Funds - 6bn (3) Unit linked funds in other insurance wrappers; generally advised sales Oversight by RL Investment Office Institutional Clients - 18bn More sophisticated clients; Often advised by consultant; many are pensions schemes with trustee board RL With-Profits Funds - 42bn (4) Individual policyholders are end investors; governance, Oversight and due diligence by RL Investment Office 1 Source: Royal London Asset Management, all figures as at 31 December 2016. Note that the breakdown shown above includes 21bn in RL OEIC/UT funds, which is also included in the other RL business and therefore benefit from multiple layers of governance and oversight. 2 RL Pensions includes 13bn invested in RL OEIC/UT funds, with its additional oversight and governance as shown in diagram above 3 Other RL Unit Linked Funds includes 4bn invested in RL OEIC/UT funds 4 RL With-Profits includes 5bn in invested in RL OEIC/UT funds 3 P AGE
1. Fund Governance RLAM agrees with the FCA s stated focus on the importance of governance and oversight of authorised funds and other products. We believe that strong governance can help to ensure that these deliver value and consistent outcomes for customers. This governance should cover a wide range of aspects which impact on these outcomes. One of the key outcomes for our funds and investments is to deliver value for money (VfM) to our customers. One important component of this is costs and another is return; this may imply a definition of VfM which is risk adjusted net return. We would suggest that meeting customer needs requires a broader definition which also includes brand, fund manager, service, TCF and conduct a holistic perspective on value for customers. While this is necessarily a more subjective measure, we believe that it more effectively matches customers requirements which will differ between customers. We note in sections 10.11 and 10.12 that the FCA has suggested several potential remedies to assist with strengthening of governance, in particular to ensure best interests of customers. At a high level these remedies are: A. Keep existing governance structure but clarify their duties B. Strengthen the requirements on senior managers of the AFM C. Change composition of existing governance bodies to create more independence D. Create an additional governance body E. Replace existing governance structures with new body F. Greater duties on trustees and depositaries We believe that the current governance structure with enhanced clarification of duties, combined with the stronger requirements under MIFID2 and SMR delivers this objective. Furthermore, as illustrated in the diagram of our customers on page 3, there are already significant governance arrangements in place across our target customer base. We do not believe that independent directors or additional governance bodies will help us to more effectively deliver value to customers. In support of this view, we have provided our thoughts and inputs in regards to these suggested remedies. In order to illustrate our comments, we have referenced our current activities in UK domiciled funds, as well as in our Irish domiciled funds for comparison purposes. The Current Model Enhanced: We believe that the current structure (Option A in the FCA paper) with some enhancements, some of which are already in process, provides a strong level of governance. In regards to keeping the existing governance structure, we believe that there are a lot of aspects of the existing structure which do help us to deliver positive customer outcomes. Using our UK domiciled fund structure as an example: Royal London Unit Trust Managers (RLUTM) is the entity which is responsible for oversight and governance of our three on-shore umbrella ICVCs. These are the Royal London Equity ICVC, the Royal London Bond ICVC and the Royal London Multi-Asset ICVC. In addition, RLUTM is AIFM for the RL Property Fund. Under the current governance structure, the RLUTM Board is responsible for overseeing the management, administration and pricing of all RLUTM funds, including overall fund management according to the investment parameters which have been established for each of the sub-funds. The Board has a schedule of Matters Reserved to it for decision making, oversight of risks, including those 4 P AGE
associated with the use of derivatives. This is one of the key responsibilities of the Board, all of which they discharge through receipt and challenge of relevant reports from those with specific delegated authority. In order to fulfil their oversight obligations, the Board meets regularly and receives reports covering investment performance, investment risk, outsourced providers, sales and financials. The Board is also responsible for agreeing and approving any new sub-funds. In addition, a comprehensive annual review of each fund in the range is undertaken. This review considers performance, objective, costs, target market, customer feedback, TCF, conduct and customer outcomes. This report will evolve further to meet the MIFID2 product governance requirements. We are in process of moving to a board which includes no front office or fund managers in order to provide for a separation of duties. We believe that this approach provides strong oversight and governance of the RLUTM funds range and that the new regulations which are already in process can help to emphasize their duties and obligations to investors. Many fiduciary duties are already found in the existing regulatory framework, UCITS, MIFID and MIFID2, AIFMD and SYSC. The Senior Manager s Regime (SMR) mandates individual accountability in the financial sector. While this regulation came into force first for other areas of financial services, it is currently being implemented in asset managers with an early 2018 proposed delivery date. This SMR, combined with the existing requirements on AFMs, provides a strong existing governance framework already, which is as described in Option B in section 10.11. Independent Directors or Additional Governance Bodies: Extending this governance further would add independent directors as described in Option C, and the fund structures in Dublin and Luxembourg most closely resemble this approach. Our experience with this approach is based on the RLAM UCITS fund umbrella which is domiciled in Ireland. For this fund range we have two independent Irish directors who work alongside and closely with our two Royal London directors. We find that this approach can add value for several reasons: - The independent directors provide additional challenge to the fund managers - They provide insight into best practice and approaches across the industry - The independent directors work closely with the internal directors which helps to share ideas and this also ensures day-to-day links directly with the business The cost of these independent directors is one of the components of the fund expenses and therefore it is important that any independent directors add value to each fund. A 2015 study by PWC on Irish Funds Independent Director Network showed that these independent directors are each typically remunerated at 20 to > 40k per annum. While this is a wide range it will depend on the number of sub funds in the umbrella company, the complexity of the funds and the resultant time commitments to that fund company. In addition, the fund company will also need to pay for Directors and Officers Insurance to cover these independents. This structure also requires additional internal resources/support within RLAM. This means that on a single sub-fund of 100m, the directors costs could be >1bps. That same cost allocated across a 2bn umbrella with several sub-funds then becomes less than 0.1 bps. We question whether this might be anti-competitive for small fund companies and actually discourage new fund innovation. For this reason, if it is determined that independent directors are appropriate and will help to ensure effective challenges, then we believe that it is especially important that independent directors are engaged at the umbrella level, rather than at sub-fund level. Given the synergies between sub-funds, this approach is most sensible and benefits all sub-funds in that range and their customers. 5 P AGE
The existing fund boards could be supplemented by the addition of a further governance body which operates alongside them. Our views on this Option D are based on our experience of the Independent Governance Committees (IGCs) in the pensions area, which have been in place for 1-2 years. We agree with the importance of this type of governance in the pensions area where firms were not previously required to have governance bodies or boards. The IGCs have been established to sit outside the business and to assess and challenge on whether the workplace pensions provide value for money to customers. We do not believe that the IGC model would provide the same level of benefit in the funds arena. Some of the issues associated with this model would be: - Authorised funds already have boards which have a range of responsibilities as prescribed by regulation as we described above under Option A - The addition of an ICG-body would add extra layers and also duplication of certain responsibilities - This could also lead to conflicts between the two bodies - An additional governance body/board would add further costs to the funds Note that both C and D contemplate independent directors. It is important that any such directors have relevant fund-related experience in order to challenge and add value. At present the UK does not have a supply of such directors. Recently Ireland has experienced challenges in finding enough qualified directors who have sufficient time available to provide the quality of input and challenge. We believe that directors should not be affiliated with a lawyer, bank or other fund services provider, as this may cause separate/additional conflicts. As part of our consideration of Option E, we have also considered the potential for 100% independent directors on fund boards: This is based on the US funds model in which all directors are independent. We believe that this model would present several challenges and that these may not outweigh the benefits. - As noted above under Option C, a combination of independent and internal directors provides the best mix of external challenge coupled with integration into the business - We believe that a fully independent board would add less value as they would be less well connected than a wholly non-independent or than a mixed board. - This approach would add significant costs which would then be borne by the investors. In regards to Option F, greater duties on trustees and depositaries, we note that the recent 2016 implementation of UCITSV and the 2014 AIFMD have both already increased the duties of and liabilities for trustees and depositaries. Under UCITSV these bodies already have significant responsibility for oversight of funds. In our experience, we have active and constructive, yet challenging, relationships with the trustee/depositaries of our funds. This enables them to provide the required oversight and governance to these funds. In summary, in regards to governance, we believe that the current model with enhanced duties and responsibilities regarding value for money provides the best outcome for our customers. 2. Fee Structures RLAM are strongly supportive of a fee model that enables all investors both retail and institutional to fully understand the costs associated with investing in the financial markets. However, with many 6 P AGE
investors, especially retail, currently unaware of the fees and charges they pay, RLAM believes the need is for much better/greater communication rather than a significant change in the methodology. We note in section 10.18 that the FCA has suggested a number of potential remedies designed to help with incentivising asset managers to control the charges taken from funds. At a high level the options presented are: A. The current OCF becomes the actual charge that is taken from the fund B. The current OCF becomes the actual charge, with managers providing an estimate of any implicit and explicit transaction costs C. There is a single charge which includes all charges taken from the fund, including both implicit and explicit transaction costs, but with an option for overspend D. There is a single charge which includes all charges taken from the fund, with no option for overspend. With each of these options there are challenges for fund managers to identify an appropriate charge for the fund. Charges are accrued over the course of a year rather than deducting the full amount at year end, for example a daily dealing fund will accrue 1/365 th of the total charge at each valuation point. In order to value the fund as accurately as possible, the fund manager will need to estimate the charge for the forthcoming year. The first challenge for managers is whether to base this on the previous year s actual charge, the previous year s charge plus an adjustment for inflation, an average of the previous three years charges or some other calculation. It is important to note that the OCF figure comprises a number of elements: the AMC paid to the investment manager (based on fund assets) plus costs of operating the fund, which are based on a variety of factors. Key costs are: Trustee fee (based on fund assets/size); audit fee (annual fixed cost); registrar fees (combination of a fixed fee per share class plus an annual cost per shareholder plus fee for each shareholder transaction); fund accounting fees (annual fixed costs plus cost of transaction processing). If the FCA considers that a single charge is a desirable outcome for investors, the rules should be simplified to clearly set out the FCA s expectations around fee range variations and the process by which fund managers can adjust the single charge accordingly. For example, high levels of in/out flows (note that these transactions are distinct from transactions in the underlying portfolio assets) by shareholders will impact on the total costs incurred by the fund. Currently, under COLL 4.3.6R, any increase in payment to the manager requires 60 days notice to investors. If the single charge were to increase yearon-year this builds in a large cost and operational burden for managers and does not appear practicable/ practical. If this requirement is retained, this could result in fund managers building in some level of tolerance when determining the single charge in order to reduce the likelihood of having to undertake repeated investor notifications. This should not unfairly penalise investors but, we believe, should also not result in a significant additional financial liability for asset managers. Further, the OCF would be calculated based on a fund size, level of shareholder transactions, number of holders, etc. at a specific point in time but in actual practice it would subject to fluctuations as these factors increase or decrease. Implementation of any change to charging structures may require approval from the FCA and shareholders, as well as increased communication with all investors. Additionally, the majority of funds are now distributed via investment platforms, and a notifiable change in fees would typically be seen as a corporate event, with a number of platforms charging an administration fee for such a change. RLAM have funds listed on 32 platforms and while not all of those would levy a fee for changing the OCF, a number of them would. With these platform charges paid for by the funds, these costs would ultimately be borne by the fund s underlying investors. 7 P AGE
We support option B in which the OCF becomes the single charge, with an agreed range for variation, and supplemented by additional disclosures of transaction charges. We believe that including transactions costs within this figure will drive unintended negative consequences and that these should not be incorporated into this single charge. We have provided additional comments on each of the four options below. Option A proposes that the OCF become the single charge. This is closest to the current practice and benefits from the fact that the idea of an OCF was introduced in 2011 when KIIDs were started and is therefore not another new concept for investors to understand. As already noted, it is important that the FCA establishes clear expectations around fee range variations and an adjustment process for them. Option A proposes that asset managers would have to cover any variation between the OCF, which is currently an estimate, and the actual on-going charges currently taken from the fund. We believe however, that it would require considerable effort to move to this approach and ensure effective implementation, as highlighted above. Asset managers would need to undertake a full investigation for each of their funds to ensure that the revised OCF is set at an appropriate level. As this approach would transfer risk to the manager, they would need to protect themselves by using a range or slightly higher total OCF. In this way the investor will get a fixed, but slightly higher, fee. While we are supportive of the approach under Option A/B, we feel that it is important to note that in other jurisdictions such as Luxembourg where this approach has already been widely implemented the total OCF tends to be higher than for UK funds. In the research which we commissioned in 2015 to explore this option, the data indicated that average total costs were about 7bps higher in Luxembourg funds than in UK funds. 2 Option B adds to the single charge as proposed under Option A and also proposes providing an estimate of any implicit and explicit transaction costs. While noting our concerns above, RLAM would be able to provide an estimate of transaction costs using historical data as the actual cost will only be known with certainty after each transaction has occurred. The estimated transaction costs figure could be provided, perhaps using an average over the three preceding years. Historical implicit costs however, would have been calculated using the methodology described in the box below. However, we are aware that some asset managers may calculate transactions using a different methodology a single consistent approach is vital for customers. For example, we note that the discussions in 2015-16 with the DWP regarding pension schemes included other views of components which could be included in the definition of transactions costs. Specifically, in relation to property assets, the development, maintenance and renting of properties which are not transaction costs, were proposed to be included. Ultimately it was agreed that these should not be included; however, this demonstrates the importance of a consistent definition across all fund types and all asset classes. This is particularly important because many customers invest in multiple types of products such as pension schemes, ISAs, and investment funds and different definitions will lead of confusion and uncertainty. It is also important to note, that during periods of market stress or heightened volatility, the estimated figure could vary significantly from the realised costs. 2 Source: RLAM study conducted by AlphaFMC and Fund-X SA, Onshore Offshore Comparison 15/04/2015. Comparison of funds across range of asset classes and considering total OCF by jurisdiction. 8 P AGE
Before investors can make fair comparisons across different funds, the FCA and asset management industry would need to agree on a consistent approach for the calculation of implicit transaction costs. Transaction Costs: The following are components of the transaction costs calculation as defined under the PRIIPs draft regulations, which aligns with the FCA preferred methodology as per the recent Consultation Paper on Transaction Cost Disclosure in Workplace Pension Plans (CP 16/30). 1. Commission paid to the broker 2. Tax any tax or stamp duty paid on the transaction 3. Other this predominantly includes dilution levies which represent a negative cost to the fund 4. Implicit costs these are the costs of the transaction which are incurred during the trade but are not billed for and which are reflected in the bid-offer spread. In line with the PRIIPs guidance, RLAM calculates the implicit cost as the price movement between the time the order was sent to a broker versus the actual execution price, multiplied by trade volume. This PRIIPS methodology is the approach which RLAM uses. Options C and D propose the inclusion of transactions costs within a single charge which RLAM believes will present a number of challenges. While explicit costs, such as broker commission or stamp duty are relatively easy to determine in advance, that is not the case with implicit transaction costs. As an example, the bid-ask spread can be influenced by a number of factors including liquidity, volatility and price none of which are known prior to trade execution. Whilst we note that the FCA and the upcoming PRIIPs regulations have tried to define implicit costs, there still seems to be a degree of ambiguity when calculating, particularly for the more complex asset classes. As mentioned above, RLAM have calculated transaction costs, assuming an investment of 50k and using the methodology from the draft PRIIPs regulations, for a number of our OEICs for the period 1 Jan 2016 to 30 Sept 2016. A representative selection of these is presented below; Fund and asset type Commission Tax Other Slippage * (implicit costs) Total Transaction Costs Fund 1 (UK equity) -0.062% -0.039% 0.035% -0.030% -0.096% Fund 2 (UK equity) -0.057% -0.045% -0.005% 0.091% -0.061% Fund 3 (Euro equity) -0.070% -0.008% 0.072% 0.046% +0.039% Fund 4 (UK credit) -0.000% -0.000% 0.023% 0.341% +0.364% * See definition of implicit costs in box above We have also compared these with the overall fund performance and the funds total OCF. Our conclusions from this analysis show that: transaction costs are small in comparison to other costs; the implicit component of these can in certain cases provide a positive benefit to investors. Although transaction costs will typically be small, it is important to remember that they will be impacted by a number of factors: current economic conditions, trading levels across the industry, and liquidity in 9 P AGE
specific asset classes; therefore, they would be expected to vary. For example in 2008 the implicit costs (spread) on credit bonds increased significantly. In RLAM s opinion, transaction costs should not be included in a single charges figure. Not only do we believe that their inclusion would be misleading and confusing for customers, we also feel it could result in outcomes and behaviours that are not in the best interest of the end investor. Specifically; It would result in asset managers taking on significantly more spread risk when trading. RLAM believe the onus should be on managers to improve disclosures, not take on more risk Managers may need to inflate the transaction cost component of the single charge figure, perhaps significantly, to compensate for the increased spread risk In more stable market environments where trading was cheaper than anticipated, profits would accrue to the asset manager at the expense of the investor Conversely, if trading had been more expensive, perhaps due to increased market volatility, asset managers may seek to control costs by limiting or halting trading. In this case, there may be an unintended consequence to the fund. It is actually less transparent and clear for customers as this approach will combine administration and transaction costs. This means that investors will not know whether the total single charge is mainly administration or mainly transactions. This will not enable a good comparison across managers. Other Costs in the Distribution Chain: More generally, there are other considerations that need to be taken into account when evaluating the fees and charges paid by investors. The investment management fees and charges are only one component of the total cost of ownership; it doesn t include the costs associated with distribution and, in some cases, investment advice. Asset managers have little or no influence over the magnitude of these costs, which are likely to be at least comparable if not in excess of any costs associated with investment management. We note with interest the FCA s proposal to undertake some further work on retail distribution as we feel that this topic should be considered with an understanding of both the manufacturing and the distribution of products. In addition, platforms have become the most prevalent transaction method for the majority of investors, and have exerted large scale downward pressure on asset management fees. Over the last several years RLAM have worked closely with a number of platforms and other intermediaries who provide us with significant distribution opportunities to launch share classes that have discounted annual management charges. For example, we created a new share at a 10% discount from the clean fee but with a minimum from that distributor of 150m. These savings have been passed on, providing retail investors in particular with access to less expensive share classes that they would otherwise not have be able to invest in. Further to this, in March 2016, we launched our Global Multi-Asset Portfolio (GMAP) range. The six funds were launched with a single share class each and AMC that is available to retail, wholesale and institutional investors. This is a model that RLAM will consider using more in future, when it is appropriate. 10 P AGE
3. Communications and Disclosure With regards to the communication and disclosure section, we are fully supportive of and agree that being clear and fully transparent is the best outcome for customers. In addition, as we have highlighted in section 1 of this document, there are a range of governance bodies, such as fund boards, depositaries, IGCs, pension scheme trustees and investment advisers already carrying our due diligence and monitoring of investments. These bodies may want and need more detailed and complex information; however, end customers need clear and straightforward information that then can understand. We believe that end customers need clear and straightforward information that they can understand and which meet their real world needs, such as income, growth or security. Firstly, we would like to consider the documentation and overlap with other FCA and EU projects. We believe we need to be careful with the various new requirements and regulations that will be available during 2018 could confuse customers further, ie the introduction of PRIIPS KIDs and its difference from the existing UCITS KIID documents. We also need to be very aware of the considerable work on these exact points that will be implemented through the work on MIFID II as well as the new requirement for transaction costs within the PRIIPS and the Smarter Consumer Communication DP15/5 and Feedback statement FS16/10 We believe many of the questions you have raised will be worked through as part of these pieces of work, so before any decision are made from this paper output alone we ask that the other active projects are taken into consideration. We cannot stress this enough: we believe it can be confusing for consumers but this is due to the number of documents that are and will be available. We as an industry need to be careful we do not end up over engineering and over complicating the various pieces of documentation available for customers. We believe that the KIID document should be the main communication tool for customers. In your paper you ask for consideration to what communication tools should be used and how. The rules in COLL 4.7 already require that we provide key information, such as short description of the investment objective and policy, performance, risks, costs and charges and other information important to helping customers compare and make decisions. This KIID document is created for all funds, and we should all be using it consistently; however, we caveat that work needs to be made to the current rules and guidance that sit around KIIDs to ensure clarity and lack of jargon. We believe that adding detail and potentially complexity to fund descriptions, such as benchmarks in fund objectives, will not benefit customers in our experience most end customers are looking for outcomes, such as to pay a regular income ; they are not looking to beat a specific benchmark. Secondly, we would like to comment on the clarity of Fund Objectives, as well as the difficulty of changing these fund objectives. We believe that it is important to listen to our customers when developing new products and when managing existing products. As part of our Fund Development process the articulation of fund objectives and policy for funds launched in the last 5 years has in our opinion been more precisely defined than in funds developed many years ago. As an example our RL UK Equity Income Fund was launched in 1984, with a stated fund objective and policy of: achieve a combination of income and some capital growth by investing mainly in UK higher yielding and other equities, as well as convertible stocks. 11 P AGE
There is nothing inaccurate with this, although it is broad in its statement. We believe that this approach is consistent with the needs and objectives of most customers who typically compare funds against each other using sector performance. A benchmark comparison is not likely to be beneficial to this type of customer. We have considered the experience of other areas of our business in how to better communicate both costs and charges and performance to customers. Comparing high level costs in a defined methodology will help build trust in the industry and allow customers to see where fair value is being created. Costs and charges should be presented in the context of the benefit which the fund or solution brings, without creating too much emphasis on the single element of costs. Ensuring the disclosure and reporting requirement are consistent within the variety of regulatory requirements (MIFID2, PRIIPS, etc) and that they are at a level which customers will understand should help to achieve this objective. On the other hand, we believe that more complex funds, tracker funds or funds targeted for professional customers may require a more detailed investment objective and policy. For example the RL Enhanced Cash Plus Fund has the following objective: The Fund will seek to outperform its benchmark, 7 day GBP LIBID, over rolling 12 month periods. Capital invested in the Fund is at risk and there is no guarantee that this target will be achieved over the 12 month rolling periods, or any other time period. Therefore, we believe that the approach to fund objectives should be flexible depending on the fund type, its target market and its investment strategy. With all objectives they need to clearly state what the fund actually does, but not so restrictive that the fund manager is not able to manage the fund effectively in response to future adverse changes in the market conditions. Rather than mandate a one size fits all approach, we would suggest that fund managers should review all fund objectives periodically to ensure consistency of stated objective vs customer communications. This may include review with the funds Depositary. This is also consistent with the product governance requirements under MIFID2. In case the fund manager does feel that it is appropriate to amend this objective, we suggest that the current FCA process could be made more efficient for changes which are clarifications. We agree that Fundamental changes should continue to go through the existing FCA approvals process and unitholder vote. However, for smaller changes, the manager should be able to implement these with minimal approvals. The current process to slightly change or clarify fund objectives is complex, costly and time intensive, which means that the manager may be reluctant to make changes as a result. The process for a simple change involves trustee interaction, legal drafting of application and circulars; FCA submission and then customer notification prior to implementation. For example, the change to clarify objective of a standard fund with 4 share classes with 10,000 customers, across 10 platforms, and with pre-notification of customers could cost up to 30k to customers. For a range of 20 funds this implies a cost of ~ 600k or for 50 funds a cost of ~ 1.5m. While there would be some efficiency in grouping multiple fund changes together, the cost of communications and platforms comprise the biggest component and will not benefit from these efficiencies. In our opinion, the process of changing a fund objective should be simplified to make these forms of change easier. The Board and the Trustee already have significant duties and responsibilities as described in the governance section of our response. Working together they should be able to agree a straightforward approach for such clarifications. Finally, we want to touch on the Education to Investors; we are of the belief that more should be done on this and believe it should be done as an educational or government level activity. Currently at primary 12 P AGE
and secondary education level within the UK, the Department of Education have implemented a nonstatutory programme called Personal, Social, Health and Economics (PSHE) education which covers many subjects as the title refers but one of these is around finances in functions and uses of money, the importance and practice of budgeting, and managing risk and when children are 14-16 years of age this expands to include income and expenditure, credit and debt, insurance, savings and pensions, financial products and services, and how public money is raised and spent. In addition, the new mathematics curriculum is intended to ensure that all young people leave school with an understanding of the mathematics skills needed for personal finance. We believe the scope of this should be looked at for best practice in combination with the FCA, asset managers and the IA, informing the Department of Education on further enhancements which will ensure this is fit for purpose and will help give the investors of the future the information they need. We believe this should be something the Government and Department of Education need to make a priority. In summary to this section, we believe that the industry needs to simplify existing documentation and be aware of the impending new changes which are coming, as well as consider how we make changes to funds more efficiently when it is in the customers best interests. 4. The Value of Active Management In your report, you have also stated that your evidence suggests that actively managed investments do not outperform their benchmarks after costs While it is true that moving to passive investments may decrease costs, it does not automatically produce the better outcome for customers. We believe that both active and passive investment management are important components of the industry. A combination of active and passive investment provides a number of key benefits: Choice for customers The presence of both active and passive funds enables customers to select from a wider range of funds which will perform differently in different market conditions. For example, a passive fund may not be the best choice in a volatile or downward market. In addition, it is important to note that customers today are looking for solutions, such as income or growth as we have described earlier in our response. While components of these solutions may be managed passively, the overall solutions, such as multi-asset funds typically include active strategy construction and asset allocation highlighting the importance in active management o deliver customer outcomes. Liquidity in the markets Active management provides valuable liquidity in the capital markets which helps them to function efficiently. This then provides benefit to investors. Stewardship RLAM has a reputation for strong stewardship of our client s assets through active engagement and discussion with the management of companies in which we invest. We use this stewardship to hold these companies to account for their activities and actions. In 2016 we voted on 11,576 resolutions at 703 companies, and we used our ownership to influence the actions and governance of these firms. For example, we focused on remuneration at Sky and separation of duties at SportsDirect. This active intervention and input is only fully effective with active management of these assets. Fixed income and active management In the fixed income area (in particular for credit bonds) data and analysis suggests that moving to a passive approach for bonds will increase overall costs due to the lower expected performance of the strategy. In addition, the nature of credit indices means that the largest 13 P AGE
index constituents are the companies which have the largest amount of debt; therefore, A passive strategy will exhibit stock and sector exposures that merely reflect levels of indebtedness. We have provided our analysis in the appendix which our Head of Fixed Income wrote specifically targeted to the Local Government Pension Scheme question. We believe that the insights and analysis in this report are still valid and current today and help to demonstrate the value of active management in fixed income. We have provided the above information on fixed income as a representative example. Similar analysis could be done on other markets, such as emerging markets equity, property or small cap equities. Overall, we believe that active management and passive management are both key components of the investment markets and that this combination helps to deliver the best customer outcomes. 5. Conclusion RLAM is supportive of the FCA Asset Management Study and its aims to provide positive opportunities to benefit all of our customers. As we have noted in our response, it is important that we also benefit form the already in progress enhancements which are expected from MIFID2, SMR, PRIIPS and other regulations. Therefore, our key views are: - We believe that the current governance structure with enhanced clarification of duties, combined with the stronger requirements under MIFID2 and SMR delivers this objective. We do not believe that independent directors or additional governance bodies will help us to more effectively deliver value to customers. - We agree that better disclosures of costs and charges will benefit customers. However, transactions costs should not be within this figure We support option B in which the OCF becomes the single charge, with additional disclosures of transaction charges. - We fully support the delivery of clear and fully transparent communications and disclosures to customers about their investments. We believe that straightforward and clear fund objectives are important to customers who are looking for outcomes, such as to pay a regular income. - We believe that active management and passive management are both key components of the investment markets and that this combination helps to deliver the best customer outcomes. We trust that our response is useful to you in your considerations ahead of publication of the consultation paper. If you require any further information on the points we have raised please do not hesitate to contact us. Yours sincerely, Andrew S. Carter Chief Executive Officer 14 P AGE
Appendix 15 P AGE