Will fund boards achieve a better deal for investors?

Fund management firms must appoint independent directors to their boards as part of the FCA’s plan to deliver value for investors 

Though couched in regulatorspeak, the Financial Conduct Authority’s (FCA’s) verdict was damning. ‘It is important the asset management industry, which looks after the savings of millions of investors, is working as well as possible,’ said executive director Christopher Woolard in May, as he unveiled the final results of the FCA’s two-and-a- half year investigation into asset managers and the open-ended funds they run. ‘But our market study found evidence of weak price competition in a number of areas.’ In other words, many fund managers charge too much.   

This, the regulator suggests, is largely because there is no-one inside fund management firms standing up for the customer. While fund managers have a regulatory responsibility to act in the best interests of their investors, their priorities often appear to lie elsewhere.

The FCA’s solution is straightforward: from September 2019, all asset managers will be required to have at least two independent directors on their boards, and these independents will have to comprise at least 25 per cent of the board.

Holding to account

Logically, this is an appealing idea. At a stroke, there will be someone to hold to account fund managers running overpriced or underperforming funds, on behalf of retail investors who are powerless to take action for themselves or blissfully unaware that they’re being ripped off.

To see how that might work, we need look no further than the closed-ended investment trust sector, where investors are shareholders in their funds. Here, company law gives independent directors on the board of every single fund a legally binding fiduciary duty to act in the interests of shareholders.   

That can make a real difference. This spring alone, we’ve seen the board of Schroder UK Growth trust sack Schroder as its investment manager in favour of Baillie Gifford, after prolonged poor returns, while at Invesco Perpetual Enhanced Income, Invesco Perpetual quit as manager (only temporarily, in the event), after the board pressured it to renegotiate charges and do away with its performance fee.   

Will the independent directors appointed by fund managers act as decisively when it comes to open-ended funds? Justine Fearns, a portfolio manager at independent financial adviser Chase de Vere, is cautiously optimistic. ‘There is no reason why it cannot work,’ she says. ‘It is already standard practice in the US; and there is a model here in the UK too, where the boards of investment trusts are 100 per cent independent. In fact, based on these two approaches, it could be argued that if we want to drive real change, independent directors should form the majority of open-ended fund boards.’   

This is an important caveat. The FCA’s proposal is for independent directors to sit on the boards of the asset manager itself, rather than at fund level, and firms won’t have to appoint more than a quarter of the board from independents. So if an independent director wants to intervene in a company fund, they may not have the power to do so.   

In practice, then, much will depend on the individuals appointed to these roles. Even a minority independent director may be able to have considerable impact with determined argument and persistence; one option open to directors could be to kick up an embarrassing fuss in public if they feel they are being ignored. On the other hand, asset managers that make more supine appointments could simply sideline their independents.   

‘I think independent boards are definitely a move for the better, providing the right people are brought in,’ says Philippa Gee, the managing director of Philippa Gee Wealth Management. ‘I would be honoured to consider such an appointment, providing I felt I could add the right value and had the time.’   

Are people such as Gee likely to get a call? The FCA says it would be happy for financial advisers past or present to be considered for the role of independent director, providing they have sufficient expertise and experience to fulfil their responsibilities. The regulator also says pointedly that independent directors need not have a financial services background; their expertise might come from professional experience, public service or academia, for example.   

That’s certainly been the experience in the investment trust sector. While many non-executives do have some sort of financial services background – former fund managers and asset management executives are plentiful – funds often look further afield, recruiting from sources such as industry, the public sector and leading universities. 

Impartial oversight

Such a non-specialist move might seem counterintuitive, but the role of the independent director is not to run the fund or to provide additional financial services expertise. Rather, independents are there to offer impartial oversight and robust challenge. The different perspective they bring from time spent in other sectors may be very valuable in this regard. Indeed, the possibility of ‘groupthink’ in industries such as asset management is a real danger. It is one reason why investment trust investors should welcome research by Canaccord Genuity which finds that the number of women on their boards has more than doubled since 2012, up from 10 per cent to 22 per cent in 2018.

None of which is to suggest that the mere act of appointing an independent director, whatever their background or gender, is an automatic guarantee that governance standards will improve. And while the investment industry itself is making all the right noises – ‘we are supportive of the role that independent directors can play’, says a spokesperson for the Investment Association – some sceptics think the move will prove to be little more than a fig-leaf.

‘What is the precise problem they are trying to solve, and how will an independent director solve this problem better than any other solution?’ asks Brian Dennehy, the managing director of Fundexpert.co.uk. He thinks improved reporting standards might be a better option; and he is far from alone in pointing out the irony of a regulatory solution that is largely aimed at delivering better value for investors, while potentially making it more difficult for asset managers to achieve it. ‘Independent directors come at a cost,’ he says. ‘That increases fund costs.’

One can see his point. The FCA itself puts the cost of independent directors to the 200 or so asset management firms in scope of the new rules at £28 million a year. It says it expects this cost to be absorbed by asset managers rather than passed on to investors, but it is difficult to imagine that no leakage will take place.

Nevertheless, the regulator insists that as part of a package of measures its new rules on independent directors will lead to a more ‘transparent, open and accountable market’. And asset managers hoping they’ll get away with paying lip-service to the idea should note that the FCA has also put down a marker – it is promising to consider raising the threshold for the proportion of independent directors on boards, possibly even to majority level, if next September’s changes don’t have the desired effect.  

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