FCA report on how managers describe their fund's investment approach raises bigger questions over active management
At some purely superficial level, Fowler Drew agrees, there must be a best efforts attempt to describe the management approach in ways that meet the Conduct of Business requirements of being fair, complete and not misleading. But the FCA ought to know (as it certainly once did) that there is far more randomness and much less control in active security selection than a statement of investment policy relative to a benchmark implies, so the more a manager attempts to comply with the spirit of COBS the greater the risk of feeding misleading expectations. Maybe that’s why the FCA requires managers to warn that past performance is not indicative of future performance, or is that limited to absolute rather than relative performance?
Fowler Drew point to another logical fallacy here: assuming that retail customers’ expectations about outcomes depend on what each individual fund says, when most investors (whether advised or self-directed) choose to hold several as a means of diversifying their active-manager risk. Even if better disclosure meant we ended up with far fewer ‘closet indexers’, the problem of paying active fees for passive results would persist because diversifying active manager risk, which would then be even more compelling, tends to result in portfolio returns on average and over time close to a passive fund but with higher charges.
The FCA review will doubtless be seized on by critics of closet indexers but, given the data evidence for all funds, that is a minor and unsurprising finding, even in a small sample like this. In his analysis Stuart Fowler argues the review ‘does support investors who opt for a passive approach but mainly by what it unintentionally suggests about the fundamental nature of active management risk and reward’.
Read Fowler Drew’s comments here.
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