Kay Review backs disclosure of funds’ transaction costs
Asset managers should fully disclose all the
costs, including transaction fees, of investing in their funds to help restore
trust and confidence in UK equity markets, according to the Kay Review.
The government-sponsored Kay Review
examined the short-termism of investment due to the perceived misalignment of
incentives in the UK equity market. It was commissioned by Vince Cable, the
UK’s secretary of state for Business, Innovation and Skills, in June 2011 and
conducted by economist Professor John Kay of the London School of Economics.
The report contains 17 recommendations, one
of which encourages the full transparency of costs, including performance fees
and estimated or actual trading costs, that are charged to a fund.
As part of its recommendation to provide
greater visibility of costs, the Kay report suggests that good practice for
asset managers should be to ensure that income generated from lending
securities is rebated in full to the fund, with any related costs disclosed separately.
The UK’s Pension Regulator has previously expressed concern that revenue from
securities lending is not always returned to the asset owner and that end
investors can be unaware that their securities are out on loan.
Kay also considered the nature of
investment decisions made by asset managers, noting that the short time
horizons on which individual portfolio managers performance is judged diminish
the attention paid to the fundamental long-term prospects of a stock.
He explained that if the performance
horizon is short compared to the ‘value discovery horizon’, i.e. the time it
takes for a security to revert back to its fundamental value after a
significant event, asset managers will likely pay more attention to the views
of other investors, rather than company performance.
“Asset managers are now competing against
each, basing trading decisions that guess company performance in the short term,”
said Kay, during a presentation of his report in London on Monday afternoon.
This pressure on asset managers to respond
to short-term events would naturally increase the turnover of stocks in a
portfolio, thereby adding to the transaction costs that are passed down to the
Kay’s view on improving the transparency of
the costs associated with investing is aligned with a recent policy review
paper by the UK’s Labour party. The paper stated that asset managers typically
only disclose annual management fees, which can make up less than a third of
overall investment costs.
UK buy-side trade
body the Investment Management Association rejected the Labour party’s claim,
referring to it as “irresponsible scaremongering” and claimed there was no evidence undisclosed costs were
causing investors to lose out.
While the UK government is conducting a
separate examination of the effect that high-frequency trading (HFT) has on
equity markets – the Foresight project led by the government’s chief scientific
adviser Sir John Beddington – it did not completely escape the scope of Kay’s
Based on estimates from TABB Group, the Kay
report noted that hedge funds, high-frequency and proprietary trading firms
account for 72% of market turnover, but a small proportion of actual
“[Respondents] were sceptical about the
claimed benefits of this activity in providing liquidity, and about whether
these benefits would actually exist in the periods of acute market uncertainty
when such liquidity might actually be required,” read the report.
However, speaking yesterday, Kay regarded
HFT as a “symptom, rather than a source” of the wider issues investors face as
a result of the short-term market dynamics.
other recommendations included the creation of an investors’ forum to
facilitate collective engagement by investors in UK companies, the need for
companies to disengage from the process of managing short-term earnings
expectations and announcements and the restructuring of incentives paid to
asset managers and corporate directors to reward longer-terms performance.