Some fund managers are using inappropriate benchmarks when determining what performance fees they charge, the Financial Markets Authority says.
The FMA has today published results of a pilot study, testing how fund managers - including those in charge of KiwiSaver funds - are providing value for money.
While performance data showed skill is present among some fund managers, the impact of fees caused the benefit of this competence to investors to disappear for most funds, the regulator said.
"Fund managers are not using an appropriate market index for their funds and/or their performance fee models – typically, through using a cash-based market index as a reference point for the performance of an equity-based fund – and there is wider fund manager scepticism about the value of a market index to determining value for money."
The FMA said that even within a small group of managed investment schemes (MIS) tested in the pilot, different Official Cash Rate (OCR)-based performance fee methods were evident.
The study cited one unnamed manager who applied a margin – a hurdle – to the OCR before performance fees could be paid, another did not.
"One participating MIS manager on this point provided information showing a very wide range of margins applied to cash benchmarks by KiwiSaver and non-KiwiSaver MIS managers, to determine performance fee eligibility."
Under the financial regulations fund managers are required to use an appropriate market index – appropriate in terms of assessing movements in the market in relation to the returns from the assets in which the specified fund directly or indirectly invests.
The FMA said it is pursuing specific matters with individual managers and, together with supervisors, will engage with the industry on the market index and commission issues.
Paul Gregory, FMA director of investment management, said: "If a fund manager is not using an appropriate market index, how do they or their investors know what their strategy is, or if it provides value for the risk investors are taking and the cost they are paying?
"We are keen to understand the basis for fund manager scepticism about the relevance of an appropriate market index to value for money. An appropriate market index is not – and is not supposed to be – easy to match or beat for passive and active fund managers, respectively."
Third parties paid substantial commission
Regarding the substantial sums paid in commission to third parties, Gregory said there were very few instances where the third party continued to provide advice or of members being made aware the fees they pay are inflated by the cost of commission.
He said some fund managers used commission as part of their business model to achieve and sustain scale – particularly important in KiwiSaver.
"The FMA and supervisors are conscious many fund managers without a bank branch network must acquire new members, and grow, through a mix of commission, marketing and incentives. Our expectations governing all three factors have been set out either through new guidance on value for money, and marketing and advertising, or industry engagement. Financial advice legislation reform, including the removal of the class advice distinction, is also relevant.
"We received feedback during the pilot, as we did in guidance consultation, that market forces would resolve poor value for money and there was no need for FMA intervention," Gregory noted. "The FMA has never disputed the market has a significant role in addressing and eliminating poor value for money. However, the FMA will continue to do what we can – and should – to enable the market to do so sooner. This view is strongly supported by large KiwiSaver providers removing or reducing their fees shortly after our guidance was published, some explicitly referencing value for money."