A seemingly technical-sounding tweak to how multi-asset funds are asked to report the costs of holding investment trusts ruffled feathers in corners of the investment industry last summer.

Now, with the decision of asset management giants BlackRock and Vanguard to disregard Investment Association (IA) guidance on the issue, some of those concerns are coming to fruition.   

As well as an uneven playing field developing, where most other asset managers are forced to report higher fees, critics argue that the negative effects are already being felt in the alternatives investment companies sector.

In addition to stymieing a UK success story, that could have wider consequences in terms of harming the green energy transition by slowing infrastructure fundraising.

The key change kicked in at the start of July last year when fund managers were told by the IA, their UK trade body, to start disclosing the underlying costs of holding listed investment companies in their annual ongoing charges.

The backstory to that involves a mesh of sometimes contradictory EU regulatory regimes. But in essence, the move aligned the treatment of closed-end investment trusts with open-ended funds, whose costs were already included in the ongoing charges figure (OCF) disclosed by funds when they invest in other funds.

A band of critics – who, admittedly, are generally protesting against what they see as a ‘synthetic’ jump in their own funds’ OCFs – argue that rather than improving fee disclosure or clarity, the move is fundamentally flawed.

But another factor at play is that as this is a change in guidance rather than regulation. Even if that change has the tacit approval of the Financial Conduct Authority (FCA), some big players have felt able to ignore it.  

Most pertinently, both BlackRock and Vanguard are not following the guidance on active or index-tracking funds.

The broad picture elsewhere is that most UK-based asset managers have chosen to follow the guidelines, including the largest, Schroders and Abrdn.

Those with independent authorised corporate directors (ACD), who tend to be smaller firms without that governance capability in-house, are very likely following the guidance, with all external ACDs believed to have made the switch.

In general, experts believe most groups have now had enough time to respond if they are going to and for updated OCFs to be published in fund accounts and elsewhere.

A Vanguard spokesperson said the firm was ‘currently undertaking a review of its costs and charges disclosures to ensure they continue to address relevant regulatory requirements, align with industry practice relevant to our funds, and provide helpful information for our investors’.

BlackRock declined to comment but a source with knowledge of the company’s thinking said they were waiting for hard regulation to be introduced, referring to the chancellor’s Edinburgh Reforms announced in December, which will supersede current guidance.

Incomparable charges

To complicate the issue, most of those railing against the change sympathise with the giant US firms’ stance, even if their own funds now look relatively more costly.

‘You’re leaving a situation where some people are doing one thing, others are doing another, and so the OCFs aren’t really comparable,’ said Hawksmoor’s Ben Conway (pictured), a campaigner on the issue.

Conway has previously expressed concerns that it will make tracker funds and passive approaches to multi-asset investing look even cheaper.

Speaking on a webinar last month, the Citywire A-rated fund of funds manager did not refer to BlackRock and Vanguard directly but said those disregarding the guidance had taken a ‘perfectly acceptable but very different interpretation of the same European regulations’.

Hawksmoor uses Maitland as an ACD, meaning the decision was taken out of its hands.

‘Most independent ACDs are loathe to go against IA guidelines lest they incur the attention of the regulator. And this is completely understandable in the wake of the attention that the post-Woodford scandal is drawing to independent ACDs,’ he said.

William Macleod, head of Gravis’ open-ended funds business, said his firm was in the same position. Gravis is a big backer of investment companies which own and operate real assets in strategies like its £843m UK Infrastructure Income fund, as well as running its own GCP Infrastructure (GCP ) and GCP Asset-Backed Income (GABI ) closed-end funds.

‘I think in some cases there’s been the emergence of, if you were looking for cool language, regulatory arbitrage,’ said Macleod.  

‘It brings quite a lot of confusion, particularly for the investor.’

He pointed to BlackRock’s ETFs in its giant iShares range, which is registered in Dublin, where similar guidance has not been implemented and the regulator is unconvinced it is necessary.

BlackRock has, understandably, decided it does not want to market the same fund in the UK and Europe with different prices, said Macleod.

‘Over here, our regulator is still maintaining the line that it does not need to be introduced. And therefore we’ve got this strange anomaly where the IA has issued the guidance, and you are left wondering, “I’m not sure why you’ve done that?”’ he said.

The situation at individual firms can be complicated.

Waverton, for example, runs both UK-domiciled and offshore funds based in Ireland. Chief investment officer William Dinning said its onshore ACD, Link, had decided to follow the guidance. For the Dublin range, however, Waverton’s ACD is not including investment companies in fund OCFs ‘in keeping with all other offshore funds [it works] with’.

Renewable infrastructure hit

Critics believe the guidance change has ramifications far beyond a row about fund of fund charges.

Infrastructure investment companies have played a considerable role in the build-out of the UK’s green energy capacity – Conway has estimated that about 40% of the UK’s battery energy storage capacity is owned by listed funds in which fund of funds managers like him have been key backers.

For these investment companies to grow, their shares need to trade at a premium to the net asset value (NAV) of their portfolios of wind farms, solar parks or other green infrastructure. That allows them to issue fresh equity, funding the construction or purchase of more of renewable capacity or battery storage.

However, over the last year the Renewable Energy Infrastructure sector tracked by the Association of Investment Companies (AIC) has massively derated. The sector, which does contain some exposure to overseas as well as UK-based assets, has fallen from an average premium of 8% in January last year to a 5% average discount at the end of last month. That slide comes despite broadly strong performance and often inflation-linked revenues.

Gravis’ Macleod said the big jump in yields on UK debt since the autumn was clearly the big factor in the derating of what are, after all, income funds. But he believes selling pressure from investors now concerned about charges as a result of the IA guidance has worsened the tough fundraising environment for renewables funds.

‘When these companies are trading at a discount it’s generally because there are more sellers than buyers. Now these [funds] who’ve been affected by the synthetic OCF are very, very substantial shareholders. They’re in a position where they’re having to sell certain quantities of stock pretty much every day,’ he said.  

Macleod said in ‘isolated incidents’, Gravis’ own fund of funds were experiencing redemptions, suggesting how selling pressure is building in the sector.   

‘When we talk to our investors and ask what’s on their mind, they’re laying the reason for redeeming specifically at the apparent cost of the ownership of the fund, where they bought at one price and [have] had the imposition of this synthetic pricing,’ he said.

What is particularly galling for critics is that if these closed-end funds were set up as normal operating rather than investment companies (or carried out the same activities in most other jurisdictions), they could perform essentially the same activities but would not produce their own OCF. As such, there would be no effect from the guidance change and they would be considered ‘free’ for managers to own.

Conway argued it was ‘ludicrous’ to consider that equity fund managers would have to disclose costs in the same way.

The situation is the same for Reits. Segro (SGRO) and Tritax Big Box (BBOX ) are both major investors in warehouses, he pointed out. However, buying the former adds nothing to a fund’s costs while, as an investment company, Tritax’s 1.6% OCF would have to be factored in.

Complications and what can be done

As unintended consequences multiply, Macleod, Conway and other detractors are less convinced the IA is fully behind the change.

‘The IA is just doing what it thinks the regulator wants it to. It’s completely understandable,’ said Conway.

Critics have been engaging with trade bodies including the IA, the AIC – the equivalent trade body for investment trusts – and EPRA, the European association for real estate investment trusts (Reits), and ultimately believe they are in a better position to navigate a solution. The London Stock Exchange is also believed to have been in touch with the FCA.

‘It’s only guidance that the IA have issued and it’s apparent that if they withdrew the guidance, then the problem actually would dissipate...,’ said Macleod,

‘Where we are at the moment is I think in something of an impasse. And I think it’s probably very uncomfortable for anyone to be asked to effectively U-turn.’

In a statement, Mark Sherwin, senior advisor on financial reporting for the IA, said the body would continue to engage with regulators to ensure fund disclosure is meaningful and effective.

‘We’re fully committed to transparency of costs and charges. Our guidance on underlying investment vehicles is intended to help members implement regulatory requirements from both the EU and UK in a coherent manner,’ said Sherwin.

While no ideal solution is proposed, Macleod suggested that multiple lines of fund pricing could be one avenue. That would allow investors to gauge the implied ‘costs’ of funds holding trusts without enshrining the ambiguity and contradictions of including those in a single disclosed price. Hawksmoor is already offering that kind of breakdown on its factsheets.

In Chancellor Jeremy Hunt’s Edinburgh Reforms, the government announced plans to repeal the Packaged Retail and Insurance-based Investment Products (Priips) EU regulation which underpins the new guidance, with a consultation closing at the end of this week.

While critics welcomed that intention, it will not produce an immediate solution. Conway said the FCA’s focus on fees under its new consumer duty principle could worsen selling pressure on investment companies.

This is uncomfortable for a sector that traditionally took pride in being cheaper than rival open-ended funds because they did not pay adviser commission. The FCA abolished commission a decade ago, removing much of close-end funds’ cost advantage. Now, the regulatory confusion over charges disclosure gives the impression they are more expensive when, in the case of renewables, they are offering access to an asset class that open-end funds struggle to provide.