Date: 19.04.16 Category: Ethics & Professionalism
Information about cost appears to be most highly valued where cost is expected to be the primary variable influencing total return. In the market for passive products, where providers are providing access to the market or factor return and not applying additional skill, price is a significant contributor to competition and to value generation for clients. Price information is thought to be less highly valued in the market for active products where providers seek to outperform the market return.
In active markets, performance is said to ‘trump’ price. Retail clients will note price, but if the promise of performance is sufficiently great, their consumption choice will be based on the expectation of future performance rather than on the certainty of future cost. However, stakeholders point to the growing new money flows going to low-cost indexed or passive products relative to higher cost active funds in the most efficient equity andfixed income markets as a sign that price competition is working in markets where persistent outperformance is less likely.
Stakeholders believe that while competition is increasingly effective in the market for new assets, it appears relatively ineffective in the market for historic assets which is characterised by inertia. They comment that the economics of investment management encourage the development of new funds, but discourage the winding up of existing funds. As it is difficult for investment firms to know with certainty which funds will draw demand in the future, there is an incentive to build and maintain a range of funds so that clients have appropriate choice, but also so that the investment firm optimises its chances of developing a ‘winner’.
The profitability of these large, successful funds can then be used to subsidise the maintenance of the broader stable and the development of future, potential winners.
Fragmentation and over-supply
The consequence of a blend of inertia and economics is fragmentation and over-supply. The large number of fund structures in the EU means that the market in aggregate is paying too much for the administration of the investment management services that it buys. Stakeholders agree that it is important that the market for investment products and services is competitive. Buying power is effective in some parts of the market and less so elsewhere.
Suppliers compete aggressively across the market, but have tended to do so on performance rather than price (other than in passive products). Despite the widely acknowledged fragmentation and over-supply that characterises the market, some stakeholders are concerned that barriers to entry should be no higher than they already are. They argue that consolidation towards a smaller number of scale providers might lead to a further adverse shift in the balance between supplier and buyer power with no balancing improvement in the net performance generated for clients.
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