In October, to coincide with the UK’s National Ethical Investment Week, Investors Chronicle published an article stating that nine out of 10 ethical or socially responsible funds in the UK would be banned from marketing themselves as such in Belgium or France because they do not meet transparency standards in those countries.
But the story misses the point, says one fund manager that does meet those standards, even though they are not compulsory in the UK. Given the battering the industry’s image took as a result of the financial crisis, transparency is an issue for all asset managers, not just for sustainable and responsible funds, according to George Latham, chief investment officer of WHEB Asset Management.
“Transparency, accountability, fund governance and the alignment of investment managers with their clients presents a set of challenges to the industry as a whole,” he says. “Whenever we talk about transparency, it definitely resonates with our client base. They say that the fund management industry is not as transparent as they want it to be.”
This is partly a reflection of the loss of trust the entire financial services sector suffered as a result of the crisis, and partly more industry specific.
“Higher levels of opacity have enabled higher levels of complexity and that was definitely a contributor to the financial crisis,” Mr Latham says. “Often people feel they have invested in a particular strategy and they have a feeling that the fund is not being managed according to that strategy. However, they do not have the tools to be sure one way or the other.”
One way this can happen is “mandate drift”. Many fund managers describe themselves as fundamental investors who invest in the quality of a business and its management. But according to Dominic Barton, managing director of McKinsey, the consultancy, the average holding period for US equities in the 1970s was around seven years. By 2011, that had fallen to around seven months.
“That has nothing to do with judging valuation or quality. That is a trading or a speculation decision,” Mr Latham asserts.
In 2010, a report from Mercer, the consultancy, examined the portfolio turnover of 900 trading strategies between June 2006 and June 2009. It revealed that almost two-thirds (65 per cent) of them had a higher turnover of stocks than those running the fund intended – on average roughly 26 per cent higher than anticipated.
This is a concern for institutional investors, says Mercer, because it increases transaction costs and because of “the risk that the strategy is not being managed in line with its stated investment approach”.
“We say our average holding period should be over three years and clients should be able to see what it is,” Mr Latham says.
SRI investors fight for transparency from the companies they invest in because they want access to non-financial data related to environmental, social and governance issues they think are important for company performance. So it is natural for them to be more open to transparency than other investors, says Francois Passant, executive director at the European Social Investment Forum. Eurosif created the transparency standards that have been made mandatory for SRI funds in Belgium and France.
“Transparency is an important part of restoring trust with the end user,” he says. “The financial industry lost such a huge amount of trust after the financial crisis.”
However, Mr Latham points out that “this is not just relevant to a sustainability investment strategy”. It is relevant to any fund that sets out its stall on how it invests, he says.
Transparency is the key to the funds industry returning to a culture of customer service and being seen as investing on behalf of its clients, rather than merely for its own profit.
For John Wilcox, chairman of Sodali, the US-based investment consultancy, there is another issue.
“It is a matter of regulatory efficiency and fairness,” he says. “Regulators impose comprehensive disclosure requirements on companies and require them to communicate with shareholders. At the same time, companies lack the information essential to fulfil these responsibilities – ie, the identity of shareholders and beneficial owners.”
But Peter de Proft, director-general of the European Fund and Asset Management Association, says it is more an issue of simplicity than transparency.
“There is no value in drowning investors in additional transparency when all the information they require is already available under directives, local regulations and accounting rules,” he says. “It is incumbent on the industry, however, to explain what we do, and our costs, in a more simple and accessible way, and we should always be looking at ways to improve how we do this.”
He suggests there could be simpler ways of explaining total cost of ownership on a historical basis. It would also be beneficial to develop a common standard for portfolio turnover rate, and to explain at the point of purchase when one should be pleased and when one should be disappointed with the outcome.
Regulators are likely to demand more transparency from all funds in future, believes Matt Christensen, global head of responsible investment at Axa Investment Managers, one of France’s biggest investors. “The European Commission is looking at labelling of the responsible investment sector and it is thinking about what could be improved for fund management generally,” he says. “I am preparing for a world of more transparency.”
But given that fund managers are not naturally inclined to reveal what they are doing, the result could be that any new regulations are treated as just another box-ticking compliance exercise. What needs to happen, according to Mr Latham, is for “what is seen as a compliance function to become a competitive advantage. If something is done for compliance reasons, it will be done as cheaply as possible. If it is seen as offering a competitive advantage, it will be done as well as possible.
“Greater transparency creates stronger relationships with clients and the more we and others can demonstrate that, the faster others will respond.”