FMA ups the ante on value-for-money project, won’t back down on original guidance

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The FMA is doubling down on its efforts to get buy-in from fund managers to its value for money report, aimed at ensuring fees and commissions are reasonable and fully disclosed to all members of managed investment schemes (MIS).

Friday, July 22nd 2022, 7:41AM 2 Comments

by Jenni McManus

Since the report was published in May, the regulator has circulated a separate discussion document, providing more detail on the key areas where the FMA wants to see change: performance fees, trail commissions and transparency.

Obtained by Good Returns under the Official Information Act, the report has not been published on the FMA’s website. It appears to represent the regulator’s thinking after receiving feedback on the pilot report, fleshing out its arguments and adding numbers to illustrate these points.

The tone of this discussion paper is calmer and less aggressive than that of the May report, which has encountered serious pushback in some quarters.

But the FMA has not backed down on its basic requirements: that fund managers should measure their performance against an appropriate market index, that trail commissions paid to third parties who introduce new members should not be embedded in a general management fee and charged to all members (including those who joined the scheme direct), that financial advice to members joining via intermediaries must be ongoing and that full transparency is required in the way fees and commissions are reported back to members.

Discussions between the FMA and industry groups is ongoing as MIS managers get to grips with a self-assessment tool the FMA has developed to get a consistent process across the sector and to enable managers to demonstrate reasonable fees and value for money.

It will listen to feedback and tweak the tool if necessary and provide more specific information about how managers should deliver, but the FMA says it is not prepared to reverse its value for money guidance, published in April 2021.

Value for money is fundamental – and does not necessarily mean “cheapest” – “and should take time to assess and evidence”. Under the KiwiSaver rules within the KiwiSaver Act 2006, fund managers have a statutory obligation not to charge unreasonable fees.

On performance fees, the discussions document covers hurdle rates of return for KiwiSaver and non-KiwiSaver managed funds.

For KiwiSaver funds, the FMA says the hurdle rate should reflect the fund’s long-term objectives and inherent risk characteristics (generally, the higher the risk the higher the required hurdle).

All non-KiwiSaver funds must report performance against the returns of an appropriate index. “Although not a legal requirement, it is reasonable to link the hurdle rate for any performance-based fee to the return of the comparative index,” the FMA says.

It notes that some funds base their performance fee on a hurdle rate linked to a market index that doesn’t reflect the asset class and risk of the underlying investment. So, even

if the fund has under-performed against its comparative index, it may still be paid a performance fee

“It is not in members’ best interests to pay a fee for outperformance of a cash-based benchmark for an equity-based fund as the risk of the benchmark and the fund are materially different and the benchmark will, over time, be simple to beat, and so does not represent value added by the manager.”

The document gives a sample of some types of performance fee benchmarks, such as 15% over OCR + 5%, no cap; 10% over 90-day bill rate; and 15% of OCR + 5%, capped.

It then demonstrates an outcome for one of them: the OCR+ margin, capped. Over the 10 years ending in 2021, the performance fee was paid eight times. Had the hurdle been  based on out-performing the fund’s market index, the fee would have been paid only four times.

On the issue of trail commissions, the FMA says the payments appear to benefit the intermediaries and fund managers, rather than investors.

There is an inherent conflict of interest because of the risk that fund choices will be based on which manager pays the highest, or any, commission. And commissions could distort competition among intermediaries and MIS managers.

‘[There is a] risk MIS managers [will] compete with commission payments to be more appealing to intermediaries, rather than competing with value for money to be appealing to investors,” the FMA says.

“[It is a] better outcome for the market to compete by providing the best value proposition to customers, rather than competing on the basis of providing the best value proposition to advisors.”

Tags: FMA

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