Closet Indexers, Expect a Call from Regulators

The UK’s Financial Conduct Authority (FCA) has criticized the country’s fund managers for poor transparency and a lack of oversight of legacy products.

Some managers failed to disclose their products’ reliance on passive strategies, the FCA said in a thematic review of communications and documentation. Of 23 funds analyzed, three were found to be following “enhanced index strategies without adequately disclosing this.”

“The strategy, indexes, and degree of freedom the fund manager had in relation to each index were not adequately disclosed to investors,” the regulator said. “Investors did not know the fund’s strategy and were unable to judge the level of risk and return they might get from the fund compared to the index.”

Two more funds in the sample were found to have “material passive holdings that were not adequately disclosed.”

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Such issues were more likely to emerge on funds that were not actively marketed, the FCA added, as these products often lacked adequate oversight or governance.

“Firms must monitor funds and treat customers fairly throughout the lifetime of the product irrespective of whether the fund is being actively marketed,” the FCA said.

Regulators in Sweden and Poland have recently turned their sights on “closet tracker” funds, while campaigners have lobbied the European Securities and Markets Authority to take action against managers that overcharge for passive products.

The review also analyzed four segregated institutional mandates but found these to be “closely overseen by the client through regular reporting and meetings with the asset manager.”

No specific asset managers were named in the FCA’s report, but firms exercising poor practice will be contacted by the regulator and “required to make improvements.”

The “meeting investors’ expectations” thematic review forms part of a wide-ranging asset management market study, in which the FCA aims to review all parts of the distribution chain including asset managers and consultants.

The “conflict of interest” rule unveiled Wednesday by the US Department of Labor will likely have little impact on institutional plan sponsors, according to Russell Investments.

Many of the proposals that had been troubling to pension plans, including a requirement that would have affected how employers can engage with employees regarding 401(k) defined contribution plans, were left out of the final fiduciary rule, said Jean-David Larson, director of regulatory and strategic initiatives.

“At first glance it doesn’t appear to be the case that the rule will have a major impact,” Larson said in an interview with CIO. “The key things that were concerning plan sponsors appear to have been addressed.”

The rule—the first meaningful change to US retirement advice regulations since the 1974 Employee Retirement Income Security Act (ERISA)—is intended to protect the interests of retirees, said Labor Secretary Thomas Perez in a speech at the Center for American Progress on Wednesday.

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“A consumer’s best interest must now come before the advisor’s financial interest,” Perez said. “Today’s rule ensures that putting clients first is no longer simply a marketing slogan. It’s the law.”

However, Larson said the existing ERISA standards already ensured institutional plan sponsors behave as proper fiduciaries.

“The institutional market has been well-settled,” he said. “It’s a well-established area of the law.”

Plan sponsors, for example, are already under fiduciary obligation to make investments that are in the best financial interests of plan participants. Therefore Larson said it was unlikely the rule will cause any changes in how 401(k) plans are set up.

“Institutional investors already look across the risk return spectrum,” he said. “Obviously fees are critical.”