FCA Asset Management Study – A recipe for success?Friday 30th June, 2017
While the final FCA Asset Management Study came down hard on the industry in terms of fees and the need for clearer performance measurement, it may have missed a trick. End-investors need to know more about their managers’ performance than just the absolute returns; it’s the consistency and the style integrity of their portfolios that lies at the heart of measuring the overall merit of the investment approach.
As BlackRock observed in a 2015 study, investment factors are to assets what nutrients are to food. If you care about being in shape, you may well pay close attention to the nutritional integrity of the ingredients in food you eat, perhaps the specific levels of fat or carbohydrates, for example.
For investors, the factor exposures in a portfolio are its ingredients. Unfortunately, the industry does a poor job of being explicit and uses broad labels such as ‘value’ and ‘momentum’ perhaps with a dash of ‘ethical investing’. These phrases are catchy, but the individual underlying style factors, not just the category, are often the key contributors to performance and certainly serve to confirm the style integrity of an investment strategy.
Factors have a number of benefits to the industry at large, not just to end-investors, and they are an important part of the picture that was overlooked by the FCA. Perhaps that is because consistency and style integrity are apparently much harder to quantify than fees and returns.
But is that entirely true? As you can see from this chart, even within a single Morningstar category of UK equity funds, the individual constituent funds that make up this category present investors with an incredibly diverse range of choices as measured using distinct investment factors. The solid line shows the neutral position of the FTSE All Share benchmark and the floating bars show the range of tilts by each of the underlying funds to and away from the index with respect to key investment factors.
Funds with style exposures outside the dotted lines are significantly different from the All Share index. While there are many funds similar to the index on some factors (darker areas on bars), there are many fund that are very different. So we can measure differences and indeed similarities between investment styles, and investors can determine which funds are consistent with their stated philosophy, and which have perhaps shown less style integrity when it comes to sticking to their knitting.
In a recent FT article, commentator John Kay argues that the key question for asset managers should not so much be, how much do you charge, or even what your returns are, but instead, “what are the unique characteristics of your approach.” I agree with him, and his assertion that asset managers should be favoured when they have a “deep and distinctive understanding of the underlying investments.” To achieve this requires an objective approach to measure the style factors that comprise the portfolio – the ‘ingredients’.
Has the FCA really created the recipe for a healthier Asset Management industry? A change in fees and performance measurement is obviously important but the report misses the dimension of consistency and product integrity for investors and could ultimately reduce the range of offerings in the market. Not only can we measure fees and performance, as shown above, we can also measure style tilts, giving another dimension of transparency into this market.