Supervisors work on finalising the VfM self-assessment tool

With the issue of its Value for Money Industry Report (Report) in May 2022, the FMA formally ushered in the period of “business as usual” annual VfM assessments to be carried on managed fund fees.  Managed investment scheme (MIS) Managers will perform these assessments on their own schemes on an iterative per fund basis.  Their licensed Supervisors will be responsible for reviewing and testing these assessments, with the FMA as regulator performing quality control sampling and intervening as it sees required in determining if there actually is VfM in a fund’s fee structure and what should be done if there is not. 

A timeline has been put in place by the Report, stating:

Due to the pilot taking longer than expected and the need for further feedback on the self-assessment tool, the FMA and Supervisors now expect the initial Value for Money review of all funds to be completed within a year of the finalisation of the tool – likely, by 31 May 2023.

[Report, p. 13]

At this stage, the self-assessment tool has not yet been finalised, and so it may be July or August 2023 that will become the relevant deadline month.

The Report continues on to state:

However, consistent with what the FMA and Supervisors have said since the publication of the VFM Guidance in April 2021, MIS Managers should be reviewing the value for money they provide to their members as a matter of course as Managers carry out one or more of their functions, including the managing and/or administration of scheme. This is especially the case where a fund does not meet the criteria and/or has one or more of the features set out above at 2.4.

[Ibid., p. 13]

(Section 2.4 referred to in the above quotation relates to a list of fees and costs that under VfM assessment would require further evidencing and potential investigation:

• Performance fees
• Advice fees (however structured, priced and disclosed)
• Separate other management or administration charges
• Other fees (such as exit fees)
• Other revenue sources charged to the fund (such as securities lending)

[Ibid., p. 12])

The key message of the above two passages about active commencement of the VFM regime is that once the self-assessment tool is ready and issued for use, MIS Managers will have a period of twelve months from then to undertake and submit their first round of VfM results to their Supervisors.  It is not necessary, nor even desirable, for MIS Managers to leave this new and prospectively heavy workload until the last month of that first year.  Ideally, recognising that the VfM regime is already on its way in as a part of their annual work schedule, MIS Managers should be looking now at when they propose to schedule their self-assessments and coordinating with their Supervisors on the matter.  

Supervisors will also have to arrange their own workloads to be able to deal with reviewing VFM self-assessments alongside all their other routine and additional work, and so cooperation and negotiation between Supervisors and MIS Managers will of necessity be the order of the day.  And this conjoint activity will of course have to be repeated year-by-year going out indefinitely into the future.  MIS Managers who issue a large number of funds will obviously have a greater workload volume of VfM self-assessments to produce than those who have a smaller range, as will their Supervisors in reviewing and assessing that work.

Supervisors, working collectively as the Trustee Corporations Association (TCA), share combined responsibility for finalising, maintaining and updating the standardised VfM self-assessment tool, a multi-page spreadsheet co-developed with the FMA that MIS Managers will use to undertake their annual assessments.  After consultations with MIS Manager clients, Supervisors have accumulated a list of changes that will need to be incorporated into the final uniform tool to make it fit for purpose to release for VfM assessments.  Foreseeably, more changes to the tool might be needed in future once the VfM regime is in full swing and shortcomings are made apparent.  Even if any more changes are imposed, the same VfM self-assessment tool will be used at any given time by all MIS Managers and Supervisors in order to avoid regulatory arbitrage.

The first year of VfM self-assessment promises to be quite onerous in terms of the amount of relevant information – both qualitative and quantitative - to be collected and populated by MIS Managers into the spreadsheets.  There will also be a learning curve for both MIS Managers and Supervisors in working out what adequate answers and supporting evidence should look like in order for an objective VfM assessment to be completed and agreed upon. 

MIS Managers can introduce some early efficiencies, such as starting out by analysing the information required in the VfM assessment tool into the common “constants” that apply across funds at the Manager and scheme level, and each fund’s particular “variables” that are distinctive to itself.  It would be easier if MIS Managers and Supervisors worked together consultatively to develop efficiencies and reduce the amount of back-and-forth communication required to complete VfM assessments, provided that the integrity of the information utilised for valid assessments was not compromised in any way.

After the first round of VfM self-assessments, the spreadsheets used could simply be updated annually for funds previously reported on (barring any subsequent self-assessment tool changes required by the TCA, which could be added in as fixes).  It could be stated per spreadsheet that there was no material change since the last time it was completed if that were the case, or, if there were changes, exactly where these were to be found in the revised version for ease of location. 

Conceivably, ongoing VfM assessments should become much more efficient for both MIS Managers and their Supervisors once the first round is completed, both sides gain learning and experience of what is required, a reusable “library” of assessments is built up, and problematic fees are identified early on so that further work can be commenced with respect to them.  Funds that do not manifest problematic fees should be pretty straightforward for VfM assessments in subsequent years, but there is no room for complacency even in respect to such funds.  VfM assessments should not become tick-box exercises, as more issues could arise with passage of time such as the relationship between fund scale and fee levels. 

Fund scale, fee levels and ongoing VfM assessments

One of the interesting questions arising with the passage of time and successive annual VfM self-assessments will relate to fund scale, given that there is an emphasised expectation in the FMA’s VfM Guidance and Report that as funds increase in scale, MIS Managers should review their fees (including membership fees for KiwiSaver schemes) with a view to sharing more of the benefits, including investment returns, with their investors.  Notably, no definition of scale is provided within the Guidance or the Report.  The FMA advises that this absence of definition is quite deliberate.  In the VfM self-assessment tool the onus is placed squarely on MIS Managers to articulate how they each think about and measure scale, determine whether or not it has been achieved, and apply the concept as a fundamental aspect of their business models.

The Guidance addresses scale as follows:

Where scale exists, its benefits are typically not shared with members.

[Guidance, p. 2]

The Guidance expands further on this issue:

Sharing financial value – useful questions for managers and supervisors

Looking at net return relative to return before fees, the member’s share of the financial value of investment management may not be appropriate if the manager’s operating margins are steadily increasing but fees remain unchanged.

• Is the member receiving the benefits of scale?
• If not, is that because fees are too high? Or is the manager overly focused on rewarding itself (or both)?

[Ibid., p. 8]

Some bases of comparison are suggested by the Guidance for considering the relationship between fund scale and fees charged to retail investors:

Internal reference points

• What fees does the scheme charge to wholesale investors accessing the same or a similar product? Wholesale investors typically have much larger balances than individual retail investors, which is a good reason why wholesales fees would be lower. However, as a group, retail investors can represent total balances as large or larger than individual wholesale balances. So, the scale benefits of larger invested sums could still be passed on across the retail group.
• What fees are paid to underlying managers? If those fees are reduced, is the saving passed on to members? If not, why not?

[Ibid., p. 12]

The subsequent Report picks up on the theme of fund scale and VfM in fund fees early on at point 1.7:

The FMA’s engagements with MIS Managers outside of the pilot had already developed our understanding of the assumptions and trade-offs embedded in MIS Managers’ business models, and how these affect their thinking about scale and profitability metrics (which vary by Manager but commonly include increasing operating margin and having sufficient profit to pay dividends to shareholders). Based on the pilot, further increasing FMA and Supervisor understanding of these assumptions is an important, ongoing focus of our MIS Manager engagement.

[Report, p. 4]

The theme is returned to later on in the Report at point 2.2:

Broadly, the revisions to the [VFM self-assessment] tool recognise and address two key issues which are discussed below: …

• Enabling MIS Managers to articulate their broader thinking on value for money and scale.

[Report, p. 12]

This statement leads on to the Report’s section 2.6, which gives more detail:

Enabling MIS Managers to articulate their broader thinking on value for money and scale

A fund’s value proposition and scale metrics can be highly specific to that fund, scheme, or MIS Manager. Revisions to the tool therefore provide MIS Managers with the opportunity to articulate:

• the value proposition of a fund (which should be substantiated by metrics and other content within the tool); and
• how they think about scale as it applies to the fund under review – including, for example, profitability, business model – to better inform the discussion required by the VFM guidance, about whether a fund’s members are sharing the benefits of scale.

[Ibid., p. 13]

The report addresses scale again at point 2.11:

We note again some MIS Managers have made material changes to their fee structures and value propositions, citing value for money and scale. This provides strong competitive reasons – alongside the statutory and conduct rationale – for MIS Managers to review their value for money sooner rather than later if they have not already done so.

[Ibid., p. 13]

The Report repeats the Guidance’s comment that benefits of fund scale are typically not shared with investors.  It also brings in a relationship between building fund scale and “paying trail commissions to third parties” (p. 9).  It should be very evident that the FMA has a strong focus on the linkage between fund scale and fund fees.  This focus is likely to persist and, as VfM assessments are repeated across the years ahead, fund scale will continue to be a perennial and strongly relevant consideration, even if other fund manager fee practices that do not provide VfM for investors have in the meantime been eliminated from the marketplace.

Where to from here with the VfM regime?

Of course, New Zealand’s incoming annual VfM assessment regime is only just getting started.  As it stands, it is not a complete or mature system and will deliver only the initial groundwork that enables just individual MIS Managers, their Supervisors and the FMA to have private insight into whether investors are receiving VfM for particular managed funds.  The missing audience for this information is the investing public, for whom arguably the VfM regime will have most constructive significance and profitable impact upon investment habits.  If investors do not know whether their managed funds are providing VfM, then they cannot take any informed action in their own best interests in respect of the matter, such as quitting a fund that is overcharging. 

Logically, VfM assessments must at some stage evolve and develop into becoming part of the mandatory annual investor disclosure cycle for MIS Managers.  This result is implied where, for example, the April 2021 media release for the Guidance states:

Paul Gregory, FMA Director of Investment Management, said: “The guidance does not tell managers what to charge and accepts managers can profit from competently managing investors’ money. But the guidance also recognises investors are paying the cost and taking the risk and, if high fees mean investors are not getting an appropriate share of that profit, the manager’s competence is far less relevant, and the investor should walk away [our emphasis].”

This theme of investors directly being able to use VfM information to evaluate their investments on a cost basis is referred to again in the Report at point 1.37:

We consider providing value for money, and being able to demonstrate that to members, [our emphasis] is not a peripheral aspect of acting in members’ best interests – it’s a core aspect of that responsibility. A simple test is how easy and comfortable it would be for a MIS Manager to explain to their investors, supervisor and the FMA why not robustly examining and evidencing reasonable fees and value for money is in their members’ best interests. Once more, it is clear some providers agree, having taken steps accordingly and cited value for money as the reason for doing so.

[Ibid., p. 10]

Thus it should come as no surprise if there turns out to be at least a two-stage implementation model for the VfM regime:

Stage 1: Commencing in 2022, annual VfM self-assessments conducted by MIS Managers, reviewed by Supervisors and overseen by the FMA.  The information arising in this phase is kept private to the parties concerned and not published.  By extension, the wider market (including competitor MIS Managers, other Supervisors, financial product distributors and advisers, and retail investors) is not privy to the particular VfM assessments performed or the conclusions reached.

Stage 2: Potentially commencing at some time in the future, annual VfM assessments would be formally disclosed to MIS fund investors as a matter of routine.  The same parties (MIS Managers, Supervisors, FMA) would be still involved in the VfM assessment production process, but the real intended audience would be the investor base of each fund assessed. By extension, the wider market also would have equal access to the same information, which by then would be publicly available.

The UK VfM precedent

New Zealand’s VfM regime is modelled on the British public disclosure-based system that has now been in operation since late 2019.  This system is slightly different in the way it is set up to New Zealand’s.  In a media release from June 2021, the UK’s Financial Conduct Authority (FCA) summarises the British process as follows:

The Collective Investment Schemes sourcebook (COLL) rules require AFMs [Authorised Fund Managers] to carry out a Value Assessment at least annually (COLL 6.6.20R and COLL 8.5.17R), to report publicly on the conclusions of the AoV [Assessment of Value] (COLL 4.5.7R(8) and COLL 8.3.5AR(5)), and to appoint independent directors on AFM Boards (COLL 6.6.25R and COLL 8.5.20R). These rules came into force in September 2019 as one of the remedies from the FCA’s Asset Management Market Study (AMMS) Final Report in June 2017.

UK-based AFMs have in some cases already produced three or more successive annual AoV reports, which they publish on their websites and include VfM disclosure per fund.  There are four samples accessible at Appendix 1 below.  It is evident from these samples that there is quite some variability in how AFMs construct their annual AoVs, which will differ from the way results will be obtained in New Zealand by using a standardised self-assessment tool across all MIS Managers.  The AoVs also rely on sign-off from independent directors of the AFMs themselves rather than external review by licensed Supervisors, which latter entities are unique to New Zealand’s financial system. 

Nonetheless, the UK AoVs do provide some useful guidance for how New Zealand’s MIS Managers might go about tackling the answers that will be required to complete the VfM self-assessment tool satisfactorily.  MIS Managers could fruitfully study these AoVs in order to swot up on what might be serviceable.  This advice does come with a caveat that in June 2021, the FCA published a scathing analysis of the quality of AoVs it had reviewed and backed that up with a detailed excoriating  review.  In its headline summary, entitled “Fund managers falling short on assessing the value of their funds,” the FCA declared as follows:

We require Authorised Fund Managers (AFMs) to carry out an AoV at least annually. This requirement was put in place after the Asset Management Market Study found evidence of weak demand-side pressure in the market for authorised funds, resulting in a lack of competition among fund providers on fees and charges.

The rules addressed this by requiring firms to assess whether fund fees are justified by the value provided to fund investors, by using a set of minimum considerations. Details of these assessments must be reported to investors together with a clear explanation of what action has been or will be taken if they find that the charges paid by investors in the funds are not justified.

Our review found that, while some had been conducting AoV assessments well, too many AFMs often made assumptions that they could not justify to us, undermining the credibility of their assessments.

When considering a fund’s performance, many firms did not consider what the fund should deliver given its investment policy, investment strategy and fees. Firms spent a disproportionate amount of time looking for savings in administration service charges that cost investors relatively little compared with the time spent reviewing the costs of asset management and distribution that typically cost investors much more.

Other firms did not meet the standards we expect by using poorly designed processes that led to incomplete assessments of value (e.g. failing to assess elements such as fund performance, AFM costs and classes of units, or failing to perform assessments at share class level).

Some of the independent directors on the governing bodies (or Boards) of AFMs did not provide the robust challenge we expect and appeared to lack sufficient understanding of relevant fund rules.

Overall, we expect more rigour from AFMs when assessing value in funds. This will help ensure that investment products represent good value.

The FCA rounded off by stating that it would be doing another AoV review within twelve to eighteen months, ominously concluding that it would “consider other regulatory tools should we find firms are not meeting the standards we expect to be necessary to comply with our rules.”

MIS Managers in New Zealand could do well to absorb the messages from these FCA AoV resources as they go about completing their first VfM self-assessment in order to avoid any obvious pitfalls.  It can be taken as read that the FMA is well aware of and familiar with the FCA’s 2021 findings and recommendations concerning AoVs.

VfM assessment model answers

It could also be helpful to consider some of the answers that the UK AFMs listed in the appendix have given on certain topics addressed in their AoVs.  Take for instance the relationship between fund scale and VfM for investors.  For Jupiter Fund Management’s Jupiter Merlin Income Portfolio, for example, benefits of scale to investors are described in a short paragraph as being  produced by dilution of fixed costs as funds under management grow and ongoing investments in the fund manager’s operating platform (Fund AoV, 31 March 2021, p.2)  For Lazard Fund Managers’ Lazard Global Equity Income Fund, the benefits are attributed, again in a short paragraph, to the fund manager’s global resources and additional services (Lazard AoV, as of 30 September 2021, p. 20). 

In the case of Schroder Unit Trusts’ Schroder US Mid Cap Fund, the fund manager states:

Your fund is larger than £1 billion and is therefore large enough to achieve economies of scale.  Schroders has implemented a scale discount of 2 basis points (0.02%) to this fund, so that these savings are passed onto our retail investors. Providing your fund remains above this threshold, you will continue to realise these savings.

[Schroder AoV, as of April 2022, p. 100]

By contrast, if the fund is under £1 billion in funds under management, then the answer for the Schroder Small Cap Discovery Fund, for example, is:

The fund you invest in is currently not large enough (defined as fund assets under management greater than £1 billion) to realise economies of scale. Therefore it does not benefit from meaningful cost savings achieved from size. However, we will continue to assess this and will notify you if the position changes.

[Ibid., p. 73]

On p. 13 of its AoV quoted, Schroders sets out its rules for applying the two basis point discount to retail managed funds above £1 billion in funds under management and claims that, “This implementation of scale discounts has reduced the cost of our products for retail investors in aggregate by approximately £2 million annually as at 31 December 2021.”

Whether these sorts of fund scale answers will pass muster in New Zealand under its nascent VfM regime awaits to be seen, but at least some idea is given as to how UK-domiciled fund managers have addressed them.  There is also the FCA’s AoV critique to use as a touchstone for whether a MIS Manager’s response to a particular VfM question, especially if qualitative, is up to the mark.  Notable too in the sample AoVs selected, is that whether a VfM answer is a “constant” or a “variable” as described above is context dependent.  For example, the fund scale answers of Jupiter and Lazard are of the “constant” variety, recurring in other fund AoVs.  By contrast, one Schroder scale-related answer appears for funds over £1 billion and a different standard answer is given for funds under that threshold, meaning the assessment could be described as a binary “variable”.

Conclusion

“The New Zealand fund manager fees VfM regime is now very close to going live and both MIS Managers and Supervisors should be poised and prepared to begin active participation within it,” said Matthew Band, General Manager of Corporate Trustee Services at Trustees Executors.

“MIS Managers, including KiwiSaver providers, should be considering when they can undertake their first VfM assessments within the year after release of the finalised self-assessment tool by Supervisors, an event which is now not far off.”

“Leaving their first VfM self-assessments until near the end of the initial twelve-month period permitted is a risky proposition for MIS Managers, given the unknowns at this stage as to workloads involved not just for themselves, but also for their Supervisors.”

“Supervisors will need to open discussions with their MIS Manager clients about scheduling for the first round of VfM assessments.”

“Wherever possible, efficiencies should be introduced for how the assessments are tackled.”

“We expect that all our MIS Managers will use a consistent VfM self-assessment tool that the FMA and TCA have developed together collaboratively in the interests of uniformity of standards, fairness to all parties who participate in the exercise, avoidance of regulatory arbitrage, and, above all else,  acting in the best interests of MIS participants.”

“We are fortunate that the UK presents some models and resources in terms of fund manager AoVs published in recent times and the FCA’s critique thereof.”

“Bearing in mind that the eventual landing point for the new VfM regime could well be mandatory public disclosure to investors as is required in the UK, MIS Managers could work towards a high standard of response through the self-assessment tool that could readily be reconfigured into UK best-practice AoV disclosure standards.”

“MIS Managers could do well to imagine that their own investors will be reading their VFM self-assessments when filling out the spreadsheets for the first time.”

For comment or more information, or to be added to the free email subscriber list of “The Supervisor”, please contact Matt at [email protected].

Appendix 1: Sample Assessment of Value Reports from UK fund managers

1. Artemis Fund Managers Limited
2. Jupiter Fund Management plc
3. Lazard Fund Managers Limited
4. Schroder Unit Trusts Limited