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17 May 2017

Financial Conduct Authority Thematic Review – Meeting Investors’ expectations

The FCA has reported on the findings of its thematic review which considered how firms ensure that they manage funds and segregated mandates as they say they will do. The Thematic Review also considered how firms monitored the distribution of their funds with a view to ensuring effective and appropriate outcomes for consumers.

The FCA has set out exactly what it wants the Thematic Review to achieve. It wants fund management firms to:

  • ensure that product descriptions are clear and correct so that they can be relied on by investors and financial advisers
  • provide effective governance and oversight throughout the whole of the fund’s life
  • identify trends that may indicate appropriate or inappropriate sales by monitoring distribution channels.

The scope of the FCA’s review

The FCA selected a sample of funds with total assets under management of around £50 billion. The fund’s strategies ranged from simple to highly complex and the funds invested in a variety of asset classes including equities, derivatives, corporate and government bonds. The funds analysed were UCITS Schemes (Undertakings for Collective Investments in Transferable Securities) sold to retail investors and most were available on execution only platforms. It is worth bearing in mind that UCITS although subject to strict governance and operating requirements are able to invest in a wide range of securities not just equities and bonds traded on recognised investment exchanges.

UCITS can include derivative based strategies and also interests in other collective investment schemes. The FCA visited the firms responsible for the funds with a view to:

  • analysing how the managers invested assets on behalf of the fund
  • reviewing how investors were considered when designing investor communications and steps that were taken to ensure that the fund documents were clear, accurate and presented information in a consistent way
  • analysing the steps taken by firms to ensure that the investment approach was consistent with statements in marketing materials.

Separately from the review of funds the FCA also reviewed four segregated mandates (each institutional investor portfolios managed by UK fund management firms) to assess how  firms communicated, managed and oversaw those portfolios.

The FCA’s findings

Clarity of product descriptions

The clarity of product description is of critical importance if investors are to understand which strategies funds follow, how fund managers will invest on their behalf and what risks are involved when investing. As the FCA remarks “Not providing enough information, or using jargon, can limit customers’ ability to  make informed investment decisions”.

The key findings of the FCA were:

  • firms generally provided adequate information about a fund’s strategy, characteristics and inherent risks
  • seven funds had quantifiable performance targets, enabling investors to measure easily if performance was as expected on an ongoing basis (the funds were either aiming to out perform an index or had a defined growth target over a specified time period)
  • descriptions regarded by the FCA as clear included specific investment criteria for certain asset types e.g. minimum bond credit ratings and an explanation in plain English of what the rating meant
  • seven KIIDs (Key Investor Information Documents) did not have clear descriptions of how the funds were managed. A particular problem with five funds was the use of a benchmark
  • related approach that was not disclosed to investors – in effect there was a risk that these funds were in substance closet trackers (i.e they were marketed as having an active strategy but the managers in practice selected investments designed to replicate the performance of an index such as the FTSE 100)
  • one fund’s KIID stated that currency risk would be hedged by the use of currency derivatives and yet some currencies were hedged and some were not. As the FCA stated this clearly presented a risk that a misleading impression was given as to the level of currency risk in the fund.
Examples of good practice

The following examples of good practice were given by the FCA:

  • a detailed explanation of investment strategy. A particular prospectus had explained the specific investment steps that the manager would usually go through to choose individual equities. The firm in question had involved the fund manager in drafting the description of the strategy. This reduced the risk that the actual strategy would deviate from the strategy disclosed to investors
  • a complex fund where marketing material included a strong recommendation for customers to seek advice. As the FCA remarked “This could help mitigate the risk of inappropriate distribution to investors who did not understand all the important aspects of the fund”
  • one prospectus described only the investments that would be used by the manager rather than any investments that might be used
  • prospectuses that help investors compare risks.
Examples of poor practice
  • one fund had a broadly drafted investment policy to invest in companies. It mentioned that the fund might also invest in government debt securities, and, cash. There was no indication of what might cause the fund manager to invest into assets other than companies. As the FCA remarked “A broad investment mandate, combined with a lack of description of how a fund manager might use the mandate, could lead to customers investing in funds that have a different asset allocation than they expect. These funds may not be appropriate for their needs”
  • inconsistency regarding the manner in which funds are presented across various sources of information. This presented a risk of customers misunderstanding the product
  • two actively managed funds did not mention in the fund’s prospectus, KIID or factsheet document that as part of the fund’s overall strategy, approximately 20% of each funds assets were passively invested to track an index
  • poor or inadequate description of risks and poor or no explanation of the consequences of risks.
Oversight and governance

The FCA has reminded firms that they must at all times act in the interest of investors when operating or managing funds. In accordance with existing product governance rules firms should ensure that products are managed in line with investor’s expectations. A key aspect of product governance is that investments match the agreed investment strategy and this should be subject to regular review and monitoring. The FCA’s paper highlights the need for firms to ensure the efficiency of distribution channels. A number of fund managers recommend that their funds only be sold with advice.

The FCA found examples of funds where advice was recommended being available on execution only platforms and the firms involved should have noticed this and revised distribution channels accordingly.

Examples of good practice included:

  • firms that built in indicators to monitor distribution and which for example picked up high levels of cancelled sales or investors selling fund investments shortly after investment. Clearly these were warning signs
  • due diligence on new financial advisers and detailed training of financial advisers in the investment characteristics and philosophy driving the fund’s investment strategy and composition.

Next steps

The FCA has asked all fund management firms:

  • to consider the findings in the paper and review current arrangements accordingly
  • to ensure that the investment strategy and associated risks of funds are explained clearly and consistently across constitutional and marketing documents.

This article was written by Kate Troup. For more information please get in touch via kate.troup@crsblaw.com or +44 (0)20 7427 6726.

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