Fund managers struggling to comply with the UK Financial Services Authority’s (FSA) new “unbundling” legislation risk wasting millions of pounds by failing to implement systems to support their own expensive in-house research teams, according to specialist software and services provider Blue Curve.
Announced on 7 May 2004, the new FSA bundled brokerage and soft commission legislation means that fund managers will soon have to unbundle the cost of investment research from the commissions paid to brokers, and instead identify it transparently in their fees charged to funds. This will lead to firms having to not only justify the value of the research they receive from brokers, but also the value they get from their own in-house research teams, on which a cost will soon have to be put.
However, Blue Curve believes that fund management companies have severely underestimated the complexity of supporting a major research capability and instead are attempting to undertake research using basic and inadequate IT systems. Although many fund management companies have hired skilled teams to produce research information, their investment in systems has lagged behind and means that some of the personnel investment will therefore be wasted as information cannot be managed and utilised effectively.
Firms also have to start putting a value on their in-house research function, and be able to justify the expense in comparison with the cost of research received from external sources. This new complexity could lead many firms to waste money on ineffective and poor value research, simply because they cannot identify the research that made a positive impact on the performance of the fund, Blue Curve says.
“The buy-side is five years behind the sell-side in its use of automation and information management systems. This is the missing link, and will become a teething problem for unbundling,” said Mark Robertson, chief executive officer of Blue Curve.
“Fund management firms have made significant investments in highly skilled research personnel, but those people need effective systems to be able to deliver their best performance, and many of those systems are not in place yet. The net result is that fund managers are less informed and poor investment decisions will be made, meaning significant wasted investment,” said Robertson.
Blue Curve believes that while fund management companies are hiring research executives with the vast quantities of expertise – generally from research units in bigger investment banks – the companies have unrealistic expectations about how their research capabilities will take shape. Many investment executives who have joined such organizations have been left frustrated at the lack of systems investment and their inability to undertake research effectively.
“Highly paid people are arriving at their new desks and then asking where on earth the systems they need are,” said Robertson. “Fund management companies must start introducing integrated research capabilities into their IT systems or their investments will have been wasted. This poor efficiency will soon be transparent when firms have to start justifying the costs of internal research when compared to the fees paid to external sources.”
On 7 May, the Financial Services Authority (FSA) confirmed that it is acting to promote efficiency and transparency in UK securities markets by limiting the scope for softing and bundling to execution services and investment research. Alongside this they are requiring the industry to develop a transparent mechanism for identifying the price of investment research included in commissions.
Currently brokers typically provide a range of additional services to fund managers. The main ones are market information technology and investment research. Services are provided under two types of arrangements – ‘bundling’ and ‘softing’. ‘Bundling’ refers to the provision by brokers of other in-house services, such as research, together with dealing in securities in a single commission charge. ‘Softing’ is the practice by which a broker agrees to pay for the supply of services from a third party to a fund manager in return for an agreed volume of business at an agreed commission rate.
In both cases, the value of the services provided is dependent on how much business the fund manager places with the broker. The costs for these services are included in the commissions which are passed through by fund managers directly as charges to their clients.
The new FSA regulatory action will be complemented by a market-based initiative led by the Investment Management Association (IMA) to develop an improved system of disclosure that clearly identifies charges for research. These measures will allow investors to make more informed decisions about services charged to fund assets by fund managers, and help to ensure that investment research and execution services are sourced in the interests of fund investors. The FSA will assess in December whether the industry’s work on enhanced transparency and disclosure is on track to achieve the desired outcomes. If it is not then the FSA will consider what further regulatory action is necessary.