Putting principles into practice
The topic of fund governance and due diligence has always been an important issue. However, fund governance for Authorised Fund Manager’s (AFM) really came to the fore in 2019 following the publication of the FCA’s Asset Management Market Study (AMMS).
This made it a requirement that independent directors should make up at least 25% of an AFM board to allow decisions to be challenged by experienced individuals not affiliated to the asset manager to ensure they represent the best interests of investors.
However, when we conducted recent research using a sample of various external third-party fund boards in October 2021, we found that AFM’s now have on average a board comprising of 30% of independent non-executive directors. While this meets the AMMS requirement, it suggests that the letter rather than the spirit of the rule is being adhered to. Best practice would be that at least 50% of the board is independent, and importantly this should include the chair of the board.
In our experience, a strong and experienced chair helps mitigate conflicts of interest, drives independent challenge and represents the best interests of investors.
Furthermore, a chair and board should not be encumbered by excessive commercial interests or other board duties, which is a risk posed by host AFMs, i.e. dedicated fund operators external to the asset manager. It is not surprising, therefore, that this host AFM model is subject to ongoing scrutiny by the FCA.
UK versus Europe
In addition, our research data shows that the AFM’s and Authorised Corporate Directors (ACD) in the UK compare relatively poorly, from a corporate governance perspective, to our sample of offshore fund structures in Luxembourg and Ireland, where the average level of non-affiliated directors on fund boards is 38% and 52% respectively.
In our opinion, the robustness of the fund structures in Ireland and Luxembourg are also generally better for representing the best interests of investors. This is because there are appointed Management Companies, with named Designated Persons or Conducting Officers, overseeing the fund boards of individual directors, which allows for an additional layer of challenge.
The independence of AFM boards also compares poorly to Investment Trusts, which are investment vehicles listed on the London Stock Exchange and subject to the FCA’s Listing Rules. These face much stricter requirements, where the majority of the board must be independent from the fund manager.
Clear as mud
Meanwhile, the same research showed that the level of transparency regarding the disclosure of relevant information of affiliations to asset management companies was lower in the sample of funds that had AFM’s.
This can be of particular concern in more conflicted business areas such as investment or fund distribution where incentives, if not well structured, mean that growth in assets under management can be prioritised over the best interests of investors.
Walking the walk
While we are focused on the best interests of investors and are always monitoring the governance processes of the funds that we invest in, at the same time we also have to ensure that our own house is in order.
This means making sure that the fund structures for the Quilter Investors range of multi-asset portfolios also comply with this principle of board independence. For example, our Quilter Investors Irish collective asset- management vehicle (ICAV) and our Quilter Investors Multi Asset Open- Ended Investment Company (OEIC) both have boards with a majority of independent directors.
By implementing the same standard of processes and principles that we are seeking in our external fund partners, we have a strong base from which we can robustly challenge firms and their approaches to ensure that best practices are being observed.
For example, our assessment framework includes a specific rating for the robustness of fund structures and fund board composition. This means we proactively challenge and engage with firms and managers that we view as operating fund structures that are below industry best practice.
In order to achieve outcomes that are in the investors’ best interests, we seek commitments from senior management at our third-party investment managers by stressing the importance of effective and appropriate levels of stewardship by fund managers. .
We have liaised with a number of chief executives and other key decision makers and recommended that their fund boards include more independent directors. And following our engagement firms have, in general, been open to implementing the suggested changes and onboarding additional non-affiliated directors to the fund boards.
We see the fund board and the surrounding set-up as an indication of how well the fund manager’s principles and policies are embedded in practice. We believe the fund boards should replicate the standards that fund managers seek when looking to invest in a security and aim for the highest levels of corporate governance.
That said, if there is a case in which we believe a fund structure or board is unsuitable and a fund manager is unwilling to engage with us or make any amendments to the board composition, we reserve the right to recommend divesting from the investment. However, it must be noted this is a last resort and we endeavour to work collaboratively with fund managers focusing on the best interests of investors.
Back to basics
Essentially, at the heart of good fund governance is independence and transparency. Delving deep enough to determine how well a fund embeds these principles can take a lot of time and resources, as well as the ongoing monitoring. But understanding how a fund operates from a corporate governance point of view, can often provide an interesting and important insight into how they are likely to manage your money, meaning the work will prove its own reward in the end.