The insider’s guide to charges

Conflicts of interest reverberate throughout the investment industry, says Rajiv Jaitly, the man who has blown the lid off murky dealings in the Square Mile. John Greenwood hears more

Very few executives who have held high posts within the shiny glass walls of the investment management industry have come out and revealed the tricks of the trade. For Rajiv Jaitly, founder and managing partner of Jaitly LLP, doing so was not so much a question of whistle-blowing but of explaining how the market works and how consumers can be protected.

“I am not doing this because I want to be a whistle-blower. All through my life I have felt my reputation is my most precious asset. But if I see something I do not approve of, I’m not prepared to go along with it,” says Jaitly.

With senior spells at Axa, Santander and Deloitte, and experience as an insolvency practitioner on some of the biggest scandals of the past three
decades – from Polly Peck to Maxwell via BCCI – Jaitly’s knowledge of the inside of financial services is unquestionable.

His report published last year, ‘Collective Investment Schemes: Costs and Charges – Implications for Consumers’, lists a catalogue of hidden charges, questionable pricing mechanisms and conflicts of interest within the fund management industry that should make it essential reading for any adviser or trustee interested in taking a proper look underneath the bonnet of pension scheme costs and charges.

Few reports have had as much influence on the workplace pensions industry as the 2013 Office of Fair Trading market study. So when Jaitly, a key member of the expert panel that advised that study, says there are still serious hidden problems with the functioning of the pensions market and the asset management industry that operates within it, his opinions are probably worth a second look.

That was precisely the view taken by the Financial Services Consumer Panel, whose November 2014 discussion paper calling for radical reform of the investment management sector was largely based on the opinions of Jaitly.

Revolutionary proposal

Jaitly says the asset management industry is so complex and open to conflict when it comes to hidden charges that he believes the regulator should consider making providers include all their costs within a single charge. Trying to untangle the existing hidden expenses will lead only to them moving elsewhere, he argues.

“The way regulation is driving everything right now is to say that transparency is the nirvana that we seek – the idea that, if you can somehow achieve 100 per cent transparency around cost, you will then achieve nirvana. And I’m afraid that is simply not the case,” he says.

Rajiv Jaitly
Rajiv Jaitly

Under one of Jaitly’s proposals, which he acknowledges is revolutionary and would require other changes in the regulatory landscape to make it work, all other costs, charges and expenses incurred by the investment manager in managing an investment fund would be borne by the manager in such a structure. While fund managers claim they have to exclude costs such as transaction charges from the AMC because they are not specified, Jaitly argues that every other business has to manage unknown and changing costs when pricing products, so why shouldn’t they?

“What’s wrong with the industry providing a single price?” he asks. “It’s no different from someone out there on Oxford Street taking a decision on a product, finding that the product fails and so having to take a loss on it; and, with other products, finding they are popular and making good profits on them.

“With the investment management industry it’s a one-horse bet. What you have is a horse owned by the investment manager but all the expenses are met by the investor and all the risks attached to it are attached to the investor. The investment manager carries no financial risk whatsoever for making the wrong decisions. In what other industry would you find that?” he says.

“We can’t expect investment managers to guarantee returns but they do need to be accountable. And that accountability needs to be driven by the ability of a fund board to sack its investment manager,” he adds. “They need to be at risk for some of their decisions.”

For Jaitly, governance is the key to a better industry. He takes a dim view of the governance currently overseeing investors’ money, most of which is conflicted, he says.

“We truly need independent governance that is free of some of the conflicts that exist right now.

“Most people will point and say: ‘Well, governance in many of these structures is independent, so what’s your problem?’ But the greatest conflict that exists – the elephant in the room – is that it is the manager who, in effect, appoints the people who govern these products.

“Ultimately, the people who are chosen are those who: a) are acceptable to the investment manager, and b) tend to accept market practice for what it is. Which is why, even today, you have issues around bundling, issues around charges, issues around disclosure to investors and the way things are being sold, and all of this is absolutely, inextricably linked together,” he says.

Asked whether he knows of a master trust that he thinks is truly independent, Jaitly is diplomatic in his response. “Can I rephrase that? So, if you can show me a master trust where the trustees of the master trust are able to fire the providers to the master trust and have sufficient independence in order to do so, then I’d say there is a chance that the master trust may be free of conflict.

“But the reality is that the commercial structure will prevent you either from firing the administrator or the provider or from using a particular investment manager’s products, so they are tied in some way.”

Jaitly also sees the institutions making a buck while transfers are taking place.

“In transferring from provider X to provider Y, it’s going to take 15 days, so you are out of the market for 15 days. Guess what’s happening to that money while it’s out for 15 days? You can bet your bottom dollar its being treasury-managed and someone else is pocketing the money – and guess who benefits? The investment manager,” he says.

Jaitly’s scrutiny of every level of the process can prove bewildering in what is a very complex business. He regards this complexity as serving the needs of the industry rather than the individual, particularly when it comes to consumer protection.

“The retail investor assumes he has protections. The relationship between an investment manager and a consumer is quite well defined but the reality is these rules don’t apply to the relationship between the investment manager and the fund they are managing. These rules are different and can be over-ridden.

“There’s a huge difference between a retail investor and a retail fund. A retail fund does not have the same protections as a retail investor. So once the money has gone in, the manager can forget about the retail investor because his contract is now with the fund and the fund can be classified differently.

“A lot of people say to me: ‘You have all these
rules on best execution so why do you have a problem?’ Best execution rules are different for different types of investor. The fund is not a retail fund unless it opts to be treated as one. The regulations are sparse and COBS 19, 20 and 21 are the only FCA rules that deal with unit-linked products.” 

Future role?

With so much criticism of the industry, how does Jaitly envisage his future role?

“My bread and butter comes from due diligence and looking at risk and that’s what I’m doing. I understand the market and the funds and therefore I’m able to talk about it. I don’t think I’m ‘sharing the secrets’.

“People might view me with reluctance if I was proposed onto an IGC or the board of a fund. I’d like to think I will get the invites but I haven’t received any yet.”

When it comes to conflicts of interest, Jaitly is no less harsh on himself.

He says: “It would be a bold statement to put me on a board but I come with my own conflicts of interest – as it could be argued that my proposing these governance structures is for my own benefit because I offer myself in providing these services. When I wrote the report for the Financial Services Consumer Panel, my own conflicts needed to be, and were, stated up front.”

Conflict or not, appointing Jaitly to a governance board would surely be a bold move for any organisation wanting to nail their colours to the transparency mast. 

Rajiv Jaitly
Rajiv Jaitly

About Rajiv Jaitly

– Managing partner, Jaitly LLP, a consultancy specialising in due diligence, risk and governance on funds

– Appointed expert to the OFT study of the pensions market published in September 2013

– Has worked with the TPR regulatory policy team on asset protection, costs, employer covenants, fund structures, capital adequacy and auto-enrolment

– Chartered accountant and licensed insolvency practitioner. Dealt with a number of major insolvencies in the UK during the 1980s and 1990s, including Polly Peck Plc, BCCI and Maxwell

– Developed an investigation methodology for Deloitte, which was rolled out in the UK and Australia

– Former head of operational risk at GAM, one of the world’s largest fund-of-hedge-fund businesses

– MD and client risk officer, Alternative Investments Group, Santander

– Deputy global head and COO, fund of hedge funds, AXA IM


Key charges laid against the asset management industry

– Fund structures are highly complex, driven by regulatory and tax requirements. Differentiation between retail and institutional investors can create further complexities, such as through the types of structure used and the creation of ‘share classes’ within a structure to accommodate different types of investor with different terms. These differences between investors are often cosmetic and do not necessarily reflect how investments are managed, creating hidden risks for retail investors, who can also pay much higher charges.

– Governance of investment funds can often be weak and conflicted, especially in vertically integrated businesses such as DC pension schemes, where affiliated companies control and manage multiple stages in the value chain, including investment management, brokerage and administration at product or wrapper level.

– Regulatory requirements on disclosure continue to omit full disclosure on all costs, such as transaction costs. The latter can form a significant proportion of the costs borne by investors.

– Fiduciary duties of investment managers to protect consumers are usually an illusion. 

– Economies of scale tend to benefit the business more than the consumer.

– Performance reporting can be very misleading. Managers can disguise investment losses when they close and merge poor-performing funds and transfer the assets to a new fund, creating significant distortions – survivorship biases – in the way performance is reported, which can serve to suppress the poor performance of the original fund in which the consumer invested.

– Regulatory arbitrage can be used by investment managers to manage risks if providers choose structures where there is an assumption of a ‘lighter touch’ regulatory regime – whether in relation to governance or costs – which may reduce the risk of sanctions if things go wrong. Regulatory arbitrage is likely to benefit investment managers and product providers, rather than consumers.