Why is the fund industry so tortuous?
May I amuse you with the sorry tale of how the fund industry from being a nice simple way for ordinary folk to invest small amounts into the stock market (all UK since exchange controls made it virtually impossible to invest anywhere else) descended into its present morass of complexity. Facilis descensus Averno.
A bit of history
Anyone who has been around the funds business for more than 50 years, as I have, would share this approach. What a simple life it was in the stone age. No one worried about costs, since fees were capped at a total of 13 ¼% over 20 years. No one ever knew why. I once asked the Department of Trade and Industry, the then regulator of unit trusts. But the head of the unit trust section (total staff 3) had spent most of his previous career in Min of Ag and Fish and, like Manuel (‘I’m from Barcelona, I know nothing’), he couldn’t help.
The 13 1/4% was typically structured either as 5% initial and 3/8% annual or 3 ¼% initial and 1/2% annual. The annual charge had to cover all expenses except the audit fee. Salesy FM Cos used to choose the 5% initial out of which all advertising or marketing had to be paid and a commission of maximum 1¼% could be paid to brokers (the stock exchange fixed commission) according the rules of the Unit Trust Association (UTA – total staff 2) the predecessor the of today’s Investment Association (total staff ?). Most distribution was D2C (advertisements in the newspapers) and the rest was through stockbrokers.
The tranquil scene on the village green was disrupted
But I have to confess my sins in spoiling the tranquil scene in this charming cottage industry. The FM Co of which I was then MD identified a new market, the insurance and investment brokers, a varied crew of former life insurance salesmen and miscellaneous advisers, at that stage completely unregulated They had been used to getting 3% or more from insurance companies for selling investment bonds (you know them, a tarted up version of an investment fund). So we decided to pay them a marketing allowance of 1 3/4 % in addition to the 1 ¼% commission, making 3% in total. I was actually the firm’s representative on the board of the UTA and was summoned to see the chairman, one of the great and good of the industry, and given a right bollocking for ungentlemanly behaviour. But it wasn’t illegal, and quite lot of other FM Cos were hopping into this new and promising sales channel.
After the pretty traumatic bear market of the mid 70s (FT 30 Index down 63%: me personally close to bankruptcy) life eventually recovered and the IFA market started to develop seriously out of the 10,000 odd local mom and pop shops that sold both general and life insurance, mortgages and so on – later to be corralled into FIMBRA. By the time I became chairman of the UTA in 1981 this was where it was at. The other development was the removal of the cap on charges. The industry had pled poverty for some time and was eventually rewarded for its efforts. Of course the fees started to creep up. No cartel but ‘if they can we can’
OEICS invade and upset the Shire
The next big development was the introduction of OEICS in 1997. The result of a brilliant bit of PR by the industry, almost as good as the City’s brilliant slogan ‘self regulation in statutory framework’ which lay behind the disastrous Financial Services Act, 1986. The original UCITS Directive had been adopted in 1985 which in theory harmonized the form and nature of open ended funds within the EU and which opened the doors to cross border sales. It should have given the UK industry, at that stage the most developed in Europe, the chance conquer the continent. But….”.we are being held back by only having unit trusts, which those funny chaps on the continent don’t understand”. So we need things like SICAVs”. Actually UK authorized funds have never sold anything other than tiny amounts overseas. And most continental European distribution by UK FM Cos has always been out of Luxembourg and Dublin, where most substantial FM Cos had established locally domiciled fund ranges some years before. I set up our Lux base for the company I was managing in 1984. The real reason the industry was keen, which everyone knew ( but not the politicians who were gung ho to open the European market for the Brits) was that for OEICS, as companies, many admin functions, registration and shareholder servicing could be charged directly to the assets of the fund and not borne by the FM Co out of its annual charge as the case for unit trusts. Yippee! So the disclosed annual charge, now moving towards 1.5% from ½ or 3/8ths not only stoked FM Co profits but could be used for marketing too by means of trail or renewal commissions. These excesses led to the RDR, which may or may not prove to be the last nail in the coffins of large active managers.
Things get even more complicated
Out of this, also, came umbrella funds, differential share classes, master feeder funds, platforms and all the rest of the paraphernalia that makes today’s funds almost completely incomprehensible to the ordinary Joe, a long way from being ‘a nice simple way for ordinary folk to invest small amounts into the stock market’. And of course that requires expert intermediation by all kinds of experts and advisers, each of which takes their slice..
Another development has been outsourcing, first to third party TPAs to cut costs. Guilty again since I started to hire out our well-developed admin functions to others in the late 70s. And now the horribly flawed rent-a-fund-manager model in which no one really knows who is responsible for what, as the Woodford disaster has shown. And by the way you can’t tell from the KIID who is actually contracted to manage the investments. This is all leading, as you rightly point out, to squeezed margins, as ETFs snap at the heels of active managers. Things will have to change.
Here comes the promo
Hey ho! I’ll just stick to our newly launched online training course, which all the preceding piffle is designed to make you look at. Having trained over 2000 industry participants over 15 years I have observed that everyone is siloed in specialist roles. As a result very few people, even pretty senior ones, in the FM industry today actually understand the nuts and bolts of the business as a whole. So we have tried to create understanding of the whole not just box ticking, exam passing compliance knowledge. If you are a member of the Investment Association you can get it at a special price from it’s IA Learning website, or just to find out about it;
All about investment funds 