FCA Survey Concludes Funds Generally Do What They Say, but There's Room for Improvement by Mickael Marsali

Investors generally make decisions on whether to invest in authorised investment funds based on a combination of marketing material, disclosure material, and investment mandates. Obviously, this means it’s paramount this information is accurate, up to date, and understandable.

In April 2016, the UK’s Financial Conduct Authority (FCA)an independent regulator funded entirely by the firms they regulate but responsible to the Treasury and Parliamentconducted a thematic review to assess whether UK authorised investment funds and segregated mandates are operated in line with the expectations investors’ reasonably come to utilizing this information.

Inspired by their Business Plan 2015/16, the FCA decided to cover 19 UK fund management firms responsible for 23 UK authorised funds and four segregated mandates, all available to retail investors and using active investment strategies.

They chose not to purusue more segregated mandates simply because the risks associated with mandates are less adverse than in funds, where oversight is carried out by the fund manager rather than directly by investors.

The goal of such a review is three fold; they want to ensure fund management firms:

  1. ensure product descriptions are correct and straightforward
  2. properly oversee funds over time, including funds that are no longer actively marketed
  3. actively identify inappropriate sales by monitoring the distribution channels they select.

Overall, the FCA found that most fund management firms are taking the proper steps to meet investors’ expectations while not exposing them to any undisclosed investment risks. However, there were a few key areas for improvement.

Clarity of product descriptions

When describing how a fund is managed and the associated risks, fund management firms must be clear and consistent between marketing documents and the fund’s disclosure documents (key investor information document and prospectus). They should provide a thorough explanation of the fund’s investment strategy, as well as specific information about the aims and asset allocation of the fund.

They found that seven out of the 23 funds’ reviewed had key investor information documents (KIIDs) without clear descriptions of how they were managed. In three of these funds, the investment strategy was constrained, and there was limited freedom in relation to a benchmark. In one fund, the jargon used was most likely not understood by most retail investors.

Providing adequate oversight and governance

It’s the responsibility of the fund manager to monitor and review stated investment objectives and ensure that the fund is being managed in accordance with its objectives. Unfortunately, when funds cease to be actively marketed, there is a risk that managers will no longer provide the same level of attention and service to those funds, neglecting to take the appropriate steps when necessary.

Of the four funds reviewed that were not being actively marketed, none of them had a clearly disclosed investment strategy. And in one case, the FCA rules that the firm’s governance did not ensure the fair treatment of customers. Each of these funds had notable issues.

Ensuring appropriate distribution

When distributing funds through a third party, the fund management firm takes on certain responsibilities as product providers. Managers must carefully monitor the distribution of their funds, ensuring they receive and process relevant sales and customer information.

Of the 19 firms reviewed, only five were found to be taking active steps in identifying trends that could indicate inappropriate sales. Two funds were available on execution-only platforms when the firm had planned for the funds to be only available with advice.

Thoughts from the FCA

As Megan Butler, FCA director of supervision for investment, wholesale and specialists, explains, “The industry needs to consider how it communicates when funds are linked to financial benchmarks.

“It is also vital funds keep investment practices under review so they match their stated aims and strategy, irrespective of whether the fund is still actively marketed because investors base their decisions on this information.”

The FCA will be writing to all the firms in the sample, providing individual feedback, requiring changes wherever they found instances of ineffective management of risk that could lead to poor customer outcomes. All fund management firms in the UK should consider the findings in this report and review their arrangements accordingly.