— Paul Amery's Blog

Archive
investment

Asset managers are up in arms about regulators’ possible designation of certain firms or funds as too big to fail.

Any move to classify individual fund managers or funds as systemically important would be likely to impose onerous new capital or liquidity constraints on the entities concerned.

By comparison with banks, which have to hold substantial capital in the form of equity or retained earnings against their balance sheet loans, asset managers operate with a relative sliver of capital backing. This makes them highly profitable. But does it also make them risky?

Asset managers’ standard defence to regulators rests on three arguments: most of us don’t use leverage; we don’t guarantee the value of our funds; and, unlike banks, who act as principals, we are agents who don’t put our own balance sheets at risk.

There are some exceptions to these statements. Hedge funds—who are asset managers—are leveraged. Constant NAV money market funds in the US have long operated with something akin to a promoter guarantee of stable value. And asset managers’ expanding activity in the secured finance (repo and securities lending) markets may incur balance sheet risks for the firms involved.

As banks’ operations are crimped by new regulation, asset managers are reportedly taking up the slack in other, riskier areas of the financial markets too, like prime brokerage, trading and leveraged lending.

But for all their current lobbying dollars, asset managers may be misunderstanding regulators’ main concern—excessive scale.

The 2008/09 crisis exposed great vulnerabilities in the structure of the financial system. Its near-failure ended up costing hundreds of billions of taxpayer dollars.

From the perspective of network theory, the single riskiest type of actor in a network is one that operates at scale and with multiple links to other players.

The failure of such a “high-degree node”—one with many links—can easily bring down the whole system.

In the financial system, regulators can take action to reduce the risk of a key player failing by forcing bigger firms to hold more capital, downsize or even break up.

By comparison with banks, asset managers’ overall significance in the financial network is open to debate.

But you can see that regulators may be concerned about the huge scale of some asset management firms, and that of some of the funds they run.  Many large mutual funds promise instant liquidity while investing in less-than-liquid assets.

The investors in those funds should be well aware that the value of their holdings may fluctuate. But are they prepared for a logjam at the exit door if everyone tries to get out at once?

Add to that asset managers’ growing involvement in traditional investment banking activities and regulators are likely to err on the side of caution in classifying them. If an asset manager were at the root of the next crisis and regulators hadn’t acted, imagine the furore. Remember AIG, an insurance company, which blindsided them last time?

For this reason the largest asset managers, and the biggest funds they run, may well face new regulatory constraints.

And for BlackRock, Vanguard, Pimco, Fidelity and State Street, the largest asset managers, restructuring and reducing scale, perhaps by the demerger of different business activities, may be the way to avoid painful new capital and liquidity requirements.

Read More

The cost of owning an index-tracking fund via Hargreaves Lansdown’s Vantage platform is going through the roof.

Vantage is the largest fund “supermarket” in the UK, designed for do-it-yourself investors looking for a convenient way to hold funds, shares, Individual Savings Accounts (ISAs) and self-invested pensions in one place.

Hargreaves highlights its platform’s key features as the safe custody of investments, easy dealing and account administration, and fund and share research.

Earlier this month the firm announced a new pricing model for its clients, prompted by incoming changes to the regulations for savings products.

From 6 April this year, the UK’s providers of fund platforms—such as Hargreaves Lansdown—will have to charge openly for the services they offer (with a two-year transition period for existing clients).

In the past, platform providers were paid by hidden rebates from the annual management charges levied by the managers of the funds they sold.

Fund managers paid these rebates to platforms as part of a lump sum that included commissions payable to the financial advisers promoting their funds. The platforms then passed part of the lump sum on to the advisers.

Understandably, this bundling of fund manager charges, platform fees and adviser commissions raised concerns that investors were receiving biased advice, paying too much for savings products and earning sub-optimal investment returns as a result.

Last year, the director of policy at the UK financial market regulator, the FCA, said that his agency’s platform reforms would ensure that customers know what they are paying and the levels of service that they can expect.

Whether clients holding low-cost index funds on Hargreaves’ Vantage platform could have expected what they will now encounter is another matter. That’s a gigantic increase in costs.

Currently Hargreaves charges between a monthly platform fee of between zero and £2 per month for a range of over 100 index funds.

From April 6 this is going up to an annual charge of 0.45% for the first £250,000 of fund investments held on the platform (there’s a sliding scale for larger holdings).

Below I’ve shown what effect this price change will have on investors using Hargreaves to hold their index funds, using two popular trackers as an example and assuming three different invested amounts: £10,000, £100,000 and £250,000.

£10,000 Fund Holding

Index Fund

Annual Fund Cost (%)

Annual Fund Cost (£)

Current Platform Cost (£)

Future Platform Cost (£)

Vanguard FTSE UK Equity

0.15

15

24

45

SWIP FTSE All Share

0.09

9

24

45

£100,000 Fund Holding

Index Fund

Annual Fund Cost (%)

Annual Fund Cost (£)

Current Platform Cost (£)

Future Platform Cost (£)

Vanguard FTSE UK Equity

0.15

150

24

450

SWIP FTSE All Share

0.09

90

24

450

£250,000 Fund Holding

Index Fund

Annual Fund Cost (%)

Annual Fund Cost (£)

Current Platform Cost (£)

Future Platform Cost (£)

Vanguard FTSE UK Equity

0.15

375

24

1125

SWIP FTSE All Share

0.09

225

24

1125

For a £10,000 index fund holding, the platform charge will nearly double from April 6. For a £250,000 holding, the platform charge will increase by a factor of nearly fifty. For any sizeable holding, the platform fees will also dwarf the fees being charged by the funds’ managers.

Hargreaves says that the new FCA rules mean it has to apply the same platform charge for all funds.

It says it’s removing the existing flat £1 or £2 per month platform fee currently levied on a number of index trackers, and applying the same “low-cost tiered tariff” across all its fund range.

“This means most investors with smaller passive holdings will be better off. Investors with larger passive holdings may pay more,” Hargreaves says in what is surely the understatement of the year.

Of course, it’s possible that the UK’s leading fund supermarket is simply trying to get rid of low-fee index fund business and to focus on higher-margin active funds. Active funds have traditionally charged about 1.3-1.5% a year and will now levy so-called “clean” fees of 0.65% to 0.75%, plus the new platform fee. For such funds, the platform fee is offset by the reduction in the headline fund charge.

A commercial objective of encouraging index fund investors to leave would be surprising, though, given the rapidly increasing market share of benchmark-tracking funds and the continuing outflows from more expensive and, in the main, poorly performing active products.

The FCA, which is tasked with ensuring competition as well as regulating the markets, now faces a dilemma. When it introduced its reforms to the UK retail investment product market in 2006, the regulator (in the guise of the FSA, the FCA’s forerunner) said it wanted to ensure better overall outcomes for savers.

The fee hikes just announced by fund platform providers hit hardest at those seeking to save at the lowest cost, suggesting the regulator’s objective is getting farther away, not nearer.

You can sign up to future blogs from this site by clicking on the envelope at the top right of the page and registering via the online form

Read More