Finance

Lionel Laurent is a Bloomberg Gadfly columnist covering finance and markets. He previously worked at Reuters and Forbes.

Fund managers haven't done too badly since the 2008 financial crisis. Assets have increased steadily, as has staffing. Their CEOs have paid themselves some juicy bonuses, described by some as "out of control."

A Good Crisis
Asset-management companies have enjoyed a lift to share prices since the financial crisis
Source: Bloomberg

Performance, though, has been patchy -- and eaten up by costs. Low-cost passive funds are piling on the pressure. With that in mind, the industry should take heed of the British regulator's attack on high fees and see it as a chance to get a better grip on spending. 

Mo' Money, Mo' Problems
Assets under management have swollen since the crisis but fee pressures are starting to appear
Source: Boston Consulting Group

The 208-page report from the Financial Conduct Authority shows a big gap between cheap index trackers and actively managed rivals, which take more risk and charge more money to beat the market. Including the cost of trading, the estimated return on a 20,000 pound ($24,700) active U.K. equity fund over 20 years would be about 14,000 pounds lower than for a passive tracker. Not a happy comparison. Actively managed investments don't outperform their benchmark after costs, the report adds.

Pain Trade
Passive fund returns beat active ones by the following percentages
Source: FCA, using estimates for a U.K. equity investment over 20 years

But competition among fund managers is weak, the FCA says, meaning fees aren't falling quickly enough. The industry might argue otherwise, with the pressure from passive funds eating into business. Still, the call for transparency is a good thing. Customers often don't understand what they're being charged or getting in return, so they have trouble comparing funds and switching between them.

The regulator wants clearer communication and an "all-in" fee for customers, including possible limits on how much managers spend on buying or selling stocks. That would -- rightly -- get them to think not just about how much they pay themselves, but how much they pay their brokers and third-party providers.

Sure, trading costs are difficult to assess before you've actually traded. That's probably why the FCA has proposed four different types of all-in fee, with varying degrees of strictness. But managers have already had to get used to FCA curbs on their relationship with brokers and what they can charge customers for making trades or analyst research.

No matter how stringent the final measures, the funds really should keep looking at all aspects of their spending. If execution and research costs come down, that provides a much clearer picture of performance -- you know, the thing customers are paying for. Aberdeen Asset Management Plc's Martin Gilbert says the FCA has lent a "sense of urgency" to giving customers a better deal.

What does all this mean for the future? The stock market didn't see the report as much of a bombshell. Shares of Schroders Plc, Henderson Group Plc and Aberdeen barely moved on Friday. But fee pressure will intensify, according to RBC analysts. While more box-ticking isn't great for the bottom line, there's room to absorb higher costs: three-year average operating margins for Schroders and Hargreaves Lansdown Plc are about 26 percent and 55 percent respectively, according to Bloomberg data, putting them in the top 20 percent of the FTSE 100.

Fat Margins
Schroders, Hargreaves Lansdowne are among top 20 U.K. blue-chips by average 3-yr operating margin
Source: Bloomberg

This isn't a kick in the teeth, more a boot to the backside. It's time for fund managers to prove their worth.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lionel Laurent in London at llaurent2@bloomberg.net

To contact the editor responsible for this story:
James Boxell at jboxell@bloomberg.net