Fund managers set for another wake up call

Fund managers have been doing very well out of their customers for a very long time. Until a couple of years ago, it was common for funds to charge between 1.5% and 2% a year - regardless of how they performed. And while some of this went into the pockets of the fund supermarkets and platforms through which the funds were sold, much of it ended up in the coffers of the investment company.

In 2013, however, new rules (known as the Retail Distribution Review) forced platforms to break out their own charges from the fund charges - and this certainly put some downward pressure on prices. Nevertheless, two years on, it's not uncommon to still pay up to 1% to the fund management company - and this is before a raft of other charges which don't fall within the quoted annual charge, but are taken directly out of the fund.

If any further evidence were needed that this industry is overbloated and offering poor value to its customers - you only need look at the sheer number of funds that exist today. The vast majority of these fail to even outperform the stockmarket over the long-term - which means the high fees that investors pay are effectively reward for failure.

We're the Millers

Over the last few years, the fund management world has been under some sustained pressure to get its act together, and start offering real value for customers - along with true transparency around how much they are really charging. Agitators in chief on the transparency front have been Gina and Alan Miller - whose True & Fair campaign has been incredibly effective at highlighting the endemic opacity in the fund world.

The Millers' crusade is not completely devoid of self-interest - they do after all have their own fund management company. But I think it would be unfair to suggest their campaign has been entirely about self-promotion. Like many others, they are angry about how much money is pilfered from investors' pots without them ever even realising. And their campaign has been effective at moving the debate on.

When Daniel Godfrey was appointed as head of the Investment Management Association - the industry's trade body - a few years ago, it quickly became apparent to him that there was a head of steam building behind the transparency movement. Although fund managers were firm in their belief that they paid their subs to the trade body so that it could vigorously defend the status quo - Godfrey set about trying to persuade them that they may be better off if they try and embrace change rather than fight it.

The industry did not agree - and a few weeks ago, Godfrey was sacked.

Change is coming

But vindication looks like it may be all but immediate for Godfrey - after the regulator announced a full market study into the investment management industry this week. At the centre of its enquiry is the question of whether consumers are getting good value from fund managers, and whether competition is really working.

I'd suggest the answer to both those questions is no - and think it's highly likely that the FCA's market study will result in a significant shake up.

Over the years, I've hummed and hawed about whether there's any value at all in active fund management - given that so many people end up getting a raw deal. But it's undeniably true that a few managers have proven that they can perform over the long run - and while they are few and far between, they can certainly say that they have justified their fees, no matter how high.

So there is certainly a place for active fund management - but rewards for the managers have to be aligned with the customers' interests. If the fund outperforms over the long-run - then the manager should get paid well. But we must move away from a system where fund managers are rewarded for failure.

True competition means fund managers going out of business

One solution is greater use of performance fees. These have started to become more popular over the last few years, but they have generally been designed in such a way that means the fund manager gets to lock in its fees for short term boosts in performance, even if the long-term picture ends up looking much worse. Performance fees can work - but they need to be set up in a way that genuinely aligns customer and investor interests.

One fund analyst commented to me that if fund managers made next to nothing when they underperformed, then many of them would go out of business. That doesn't trouble me in the slightest. In fact, it sounds like the makings of a healthy market.