Ian Sayers, Chief Executive
Welcome to ‘Beacon’, the AIC’s new newsletter for investment company directors. In each edition, we will look at some of the issues of the moment in the investment company sector, offering our own and external viewpoints.
In this edition, we take a look at directors’ fees with Richard Clarke of Trust Associates, KIDs and Chair tenure. Please click on the ‘Contents’ tab at the top of the page to see chapter headings so that you can dip in and out according to what interests you most. Please do let me know if there are topics which you would like to see covered in future editions.
2018 has been another positive year for the investment company sector, with assets reaching all-time highs yet again, approximately doubling since 1 January 2013 and growing faster than open-ended funds. Average discounts remain close to all-time lows, barely widening despite market setbacks in October. After a slow start, fundraising picked up sharply in the second half of the year, with October seeing the strongest month for 5 years, when more than £2bn was raised. The total for the year now stands at over £7.5bn.
Whether this strong run can continue next year in light of Brexit and other uncertainties remains to be seen, but with interest rates at historically very low levels and the demand for alternative (and often illiquid) assets still high, the drivers of recent success remain very much in place.
The AIC will not be sending Christmas cards (electronic or otherwise) this year, but instead will be making donations to three local and national charities chosen by the AIC staff. Which means that it only remains for me to wish you a Merry Christmas and a prosperous New Year.
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For what it’s worth
The latest trends in director remuneration, by Richard Clarke of Trust Associates
How do you decide what is the right level of fees to pay your board? The answer is complex and depends on a number of factors. Directors who have been on the boards of commercial companies are often surprised by the relatively low fees paid to the boards of investment companies and there are two principal reasons why this is the case:
1. It is a crowded market, where many high-quality people who have ended their executive careers before the official retirement age, and who wish to remain involved in the asset management industry, turn to building a portfolio of directorships. So, the effect of supply and demand means that most accept fees that are lower than might be expected for the calibre of directors.
2. There is a strong focus on keeping costs as low as possible in the investment company sector and directors’ fees are just one element of that. Many directors tell us that they don’t sit on the boards of investment companies for the money but for the satisfaction of being involved in companies that they care about. Nevertheless, it is important that directors are paid a fair fee for their work as the role involves a significant level of responsibility and risk.
At Trust Associates we have carried out an annual survey of the fees paid to the directors of investment companies since 2004 and have observed some clear trends in how fees are set. There is a correlation between the size of the assets under management and fee levels. This is unsurprising as size brings a higher profile, scrutiny and risk, and means that there is less impact on the overall cost ratio. The complexity of the mandate, which often determines the amount of time the board spends on the affairs of the company, also has a clear impact on the level of fees.
Domicile has a substantial impact on directors’ remuneration, with companies domiciled in the Channel Islands paying fees at least 35% above UK domiciled companies. There appear to be two reasons for this: a large number of investment companies are competing for a limited supply of Channel Islands based directors and a high proportion of Channel Islands companies invest in alternative assets, which are more complex and time-consuming than listed equities.
"There is a correlation between the size of the assets under management and fee levels. This is unsurprising as size brings a higher profile, scrutiny and risk, and means that there is less impact on the overall cost ratio."
Richard Clarke, Trust Associates Limited
These factors are demonstrated in the table, which was compiled from information published in annual reports for financial years ending between April 2017 and March 2018. We have excluded the fees paid to Chairs of £110,000 or more, which are usually because those Chairs undertake a partly executive role or are paid fees that reflect their status, often as public figures. The impact on average fee levels of both size and geographical location is clear.
Another trend that we have observed is that, increasingly, different fees are paid for specific board roles. It has long been the case that Chairs have been paid more than the rest of the board and more recently Audit Chairs have also been paid a higher fee. A crude rule of thumb appears to be that the Chair is paid 50% above the directors’ fees and the Audit Chair 20% more, but these vary considerably between boards.
The senior independent director and other key committee chairs are increasingly paid an increment where those roles occupy additional time, but this is not sufficiently universal for us to be able to produce meaningful average figures.
The bar chart on the previous page shows the ten-year history of the sector average fees from our surveys but it should be stressed that they disguise a wide spread of fee levels and a wide variety of investment companies.
When setting directors’ fees, boards need to take account not only of the overall investment company sector norms but those of their peer groups and also of the risks, demands, visibility, size and location of the individual company. Many boards find it awkward to determine their own remuneration and prefer to ask a third party to make an impartial recommendation, which they can disclose in their annual report. Some boards also find it difficult to raise fees at a time when the share price has fallen.
We have observed that a high proportion of boards only raise their fees every three years and some even less frequently. This means that when they do raise them, they often need to do so by a significant amount because they have fallen behind the trend and this can draw unwelcome attention. We recommend a modest regular annual increase to ensure that doesn’t happen and also to be able to attract the right quality of new directors when recruiting.
Richard Clarke, Trust Associates Limited
Curiouser and curiouser
Ian Sayers explains why the puzzling case of Chair tenure demonstrates why the FRC should be put on a statutory footing
The AIC spends most of its time arguing against inappropriate regulation being imposed on its members. We less often argue for regulation of other sectors, though we do not shy away from it when necessary. The regulation of proxy voting agencies is a case in point, which will be delivered via the Shareholder Rights Directive.
It is even rarer for us to propose that regulators be subject to additional regulation, but this is what the AIC has done in calling for the FRC to be put on a statutory footing. Though not in response to the issue of Chair tenure, it does provide a timely example of why we think it is necessary.
If possible, I am going to ask you to put your personal views on Chair tenure to one side. Though the AIC is against tenure limits, it recognises that there are a range of views on this topic amongst member directors about the need for regular refreshment versus the value of experience and ‘corporate memory’.
“The requirement in Provision 18 to submit all directors for re-election annually, combined with the criteria for non-executive directors and chairs to be independent, will lead boards and shareholders to carefully consider each individual director’s contribution to the board, and their effectiveness and independence, without the need for setting a maximum period of tenure.”
We couldn't agree more - The FRC’s original position on tenure limits.
The FRC’s consultation presented a very cogent case against a tenure limit for directors which the AIC supported. You can imagine our surprise when we learned, very shortly before publication of its final Code, the FRC was proposing a tenure limit of 9 years for the Chair alone.
The AIC immediately objected to the FRC’s decision on the grounds that it had consulted on the basis that tenure limits were not required and so would not have had the full range of views or evidence from those opposed to such a limit. However, in the very little time available, we were unable to secure a change of approach.
At this point, we wondered whether respondents to the consultation had overwhelmingly supported such a change, as this seemed the only possible explanation for such a ‘volte face’ without another round of consultation. Things became even more curious, and worrying, when we discovered that, based on the published responses, almost no-one had, in fact, supported such a change.
We analysed some 230 public responses to the consultation. This was not always easy, as the FRC’s consultation did not separate the question of Chair tenure from director tenure. But we discovered:
78 respondents did not respond at all on tenure limits
104 respondents opposed having any tenure limit for directors
Only 9 respondents were in favour of a tenure limit for directors
Only 86 respondents commented on the tenure of the Chair specifically. However, of these:
63 were opposed to any tenure limit
8 respondents argued for a longer tenure limit for the Chair
Only 4 respondents supported the 9 year tenure limit for the Chair
So, not only did the FRC not consult properly on this issue, there was virtually no support from respondents for the final decision taken.
A cornerstone of sound regulation is to gather evidence of the impact of any change. The FRC did not have this to hand, as the AIC could not provide it in the time available. Now we know that, by H2 2020 (when the first reports under the new FRC Code will be produced) there could be as many as 170 investment company boards affected.
At this point, someone in favour of tenure limits might be tempted to chip in that this demonstrates that there is an issue that needs tackling in the investment company sector, but that ignores my earlier plea to separate the decision from the process. And, in any case, if the case for a tenure limit is so compelling and obvious, why did so few respondents support one?
We tend to take proper consultation processes for granted in the UK. Indeed, one of the frustrations of the European policy making process is that principles of sound regulation are not as ‘hardwired’ into the system as they are in the UK. But the case of Chair tenure demonstrates what can happen when those processes are ignored. Namely, a decision taken without consideration of its impact and almost entirely against the published views of those consulted.
The AIC continues to make the case for the AIC Code to diverge from the FRC Code on this issue, and you can read our latest submission here. We will keep members informed of any progress we make. Though this may delay the release of the AIC’s Code into the New Year, feedback from our recent director roundtables suggests that boards support us taking this extra time.
Putting the FRC on a statutory footing, of course, won’t prevent poor decisions. But the accountability that a statutory footing provides should, at least, ensure that decisions are taken with the full evidence of their impact to hand and justified by reference to the responses received.
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Guy Rainbird explains how the EU’s approach to tackling the problems with KIDs is misplaced
Guy Rainbird, Public Affairs Director
Imagine you phoned the fire brigade when a fire had just broken out in your home. You would not be pleased to be told that no fire-fighters could come to help as they were too busy handing out smoke detectors to your neighbours. An actual fire, surely, should be prioritised over protecting others from possible future ones?
Yet this is how the risks of Key Information Documents (KIDs) are being dealt with by European policymakers, risks which have been so amply demonstrated by the AIC’s submission Burn before reading.
Last week MEPs, with the support of the European Commission, decided to delay giving KIDs to retail investors purchasing UCITS funds. This delay is a racing certainty to be formally adopted by the EU in the new year. So, instead of KIDs being given to all prospective retail investors at the start of 2020, they will not be required across the market until 2022.
The only justification to delay KIDs for UCITS is that they are misleading and potentially harmful to consumers. The AIC has been telling all who will listen that these disclosures are toxic. Too often they understate risks and overstate likely returns. Investment companies can be excellent investments for many retail consumers, but buyers should not be misled into purchasing shares. Our efforts to sound the alarm about KIDs makes it incredibly frustrating that we have not received a swift response to our warnings.
It is not a bad thing that investors in UCITS will be protected from KIDs. What is impossible to understand is how the European authorities could justify protecting consumers of one product (UCITS) but not others (investment companies) facing immediate harm.
"Investment companies can be excellent investments for many retail consumers, but buyers should not be misled into purchasing shares. Our efforts to sound the alarm about KIDs makes it incredibly frustrating that we have not received a swift response to our warnings."
Guy Rainbird, Public Affairs Director
A recent consultation paper issued by EU regulators at least shows some willingness to accept there may be a problem. Unfortunately, the options for reform put forward are woefully inadequate. Many could make the situation worse. They will not work because they tinker with the existing rules rather than seeking to change their overall, flawed framework. In the absence of fundamental changes any measures brought forward are doomed to fail.
Presumably the delay in applying KIDs to the UCITS market is to allow time for a full review. This might open the way to identifying better options to fix the rules before UCITS are sold using KIDs. That may provide relief for those investors but, for now, no effective steps are being taken to protect consumers receiving flawed KIDs today.
The possibility of overhauling KIDs in the future must not stop measures being taken now to protect consumers. National regulators should be given new powers to suspend KIDs if they are misleading. Any suspensions would lapse when the KID is imposed on the UCITS market. This will protect consumers while a root and branch reform process is underway.
"In the absence of an EU solution, the UK authorities should educate consumers about the problems with KIDs. They should prevent these disclosures contaminating the broader distribution environment."
Guy Rainbird, Public Affairs Director
In the absence of an EU solution, the UK authorities should educate consumers about the problems with KIDs. They should prevent these disclosures contaminating the broader distribution environment. Over optimistic performance scenarios should be banned from financial promotions. Misleading risk indicators should not be used as the basis for automated advice processes or for online product filtering tools. These are the sort of steps that the FCA and others can take immediately irrespective of the EU view. The AIC will be pressing for them to be taken.
But, in the meantime, let’s put out the fire today, then think about how we can stop one breaking out in the future.
Public Affairs Director
T: 020 7282 5553