Value Assessments

You may have seen commentary in the financial press that refers to a Value Assessment. This is a relatively new concept within financial services, so we intend this article to demystify the subject and provide Five Wealth’s view on how the Value Assessment report can support what we do towards helping clients achieve their objectives.

What is a Value Assessment?

The Value Assessment was introduced in 2019 as part of the Financial Conduct Authority’s (FCA) new measures aimed at improving outcomes for investors. It originated directly from the FCA’s Asset Management Market Study, which stated that there was evidence of weak price competition in many areas of the asset management industry.

The new rules and guidance require fund providers to determine whether they consider their individual funds to be providing good value and take appropriate action where they are not providing value.

The assessment must be performed at least once a year. It must consider whether the fund is delivering value against stated objectives and importantly it considers the cost of achieving this objective. A report must be published each year describing the assessment they have carried out, as well as its conclusions.

To ensure a level of independence at least two independent non-executive directors (INEDs) are appointed in the role of overseeing the Value Assessment process.

How is Value Assessed?

Value is a subjective concept and therefore, firms are required to consider value against a minimum of seven criteria, which includes the cost in the context of comparable market rates, but also requires the quality of service and performance to be considered when assessing what is a good outcome for investors. The assessment is made for each share class of a particular fund and so you may find that one particular share class does not offer value, whilst other share classes of the same fund might succeed in providing value.

The finished report should help advisers and clients to consider those specific factors most important to them as an individual investor, as well as considering overall value.

Benefits

The first year of Value Assessment reports has resulted in positive action in favour of investors, including share class transfers, the closure or merger of poor value funds, and detailed analysis and challenge of underperforming vehicles.

Limitations

The FCA has not provided a template for these new Value Assessments, so it is up to the fund provider to decide how best to present the information, and this results in a lack of uniformity across the industry. This does not make it easy for investors to compare assessments on a like for like basis.

How Five Wealth use the Value Assessment?

As part of our initial fund research and ongoing monitoring of a fund on the Five Wealth panel, we will review the annual Value Assessment document. When considering a new fund, we would expect confirmation that the fund is considered good value on the basis of this analysis. For a fund that is already on the Five Wealth panel, we ensure that we review the Value Assessment report on an annual basis. Again, we would expect the fund to offer overall value. However, where there are concerns/issues raised about any individual measurement of value or the overall fund, we will investigate this further, assessing any potential impact for our clients, engaging with the fund group to challenge and understand the scope of the board’s remedial action and take appropriate action when necessary. Where we feel that this engagement has an unsatisfactory conclusion, we will remove a fund from the panel if we believe that it is having a detrimental impact on client outcomes.

Of course, this work will only support the existing monitoring of funds on our panel, as we already have a robust and thorough investment process to assess the ongoing performance (including cost, risk and return characteristics) of the fund, as well as identifying any factors that might impact the fund’s ability to meet objectives (e.g., liquidity and capacity, fund management or process changes). This is achieved through analysis of monthly performance and risk data, quarterly Five Wealth investment committee meetings, as well as regular contact with the fund manager and maintaining close contact with the fund group to ensure we are abreast of any relevant information and developments on a timely basis.

Future evolution

We do not think the introduction of value assessments is a concluded development. Several factors need to be addressed (e.g., consistency and confidence in the process of analysis) and there are also opportunities to widen the scope of these reports to the benefit of both investors and fund providers.

Moving forward, we could see greater regulation or more “best practice” guidance to improve consistency in the assessment of value and reporting. In doing so, we might reasonably expect further action on poor value funds. Whilst it is right that such action is undertaken, it may also result in more disruptive fund mergers or fund manager changes within the industry.

As ESG factors move front and centre in the industry, we might see fund groups incorporate an analysis of these factors in the value assessment, which could make it easier for investors to identify how important this is to a fund’s mandate, process, and outcomes.

Finally, in focusing minds and forcing remedial action where necessary, the value assessment may become a most important tool for the active fund manager to demonstrate their value at a time when passive investment approaches grow in popularity.

Technology in a COVID-19 world and beyond

This is not a new trend

In the past couple of years, we have noted an increased focus on technology when we talk with fund managers. The tidal wave of new technologies is not just an important factor for managers of technology funds but rather an essential consideration for managers of all investment strategies, impacting the ways in which they invest, the types of companies they invest in and the way that broader investment markets behave.

Technology in the wake of a pandemic

With the emergence of a global pandemic, these themes have accelerated in ways we would never have anticipated and the recognition of this has been seen recently with technology sectors continuing to outperform this year. There will inevitably be ‘winners’ and ‘losers’ in a post COVID world and what has become clear is that winners and losers will need to be considered over different timeframes and that the impact of the pandemic may be more nuanced and therefore require more fundamental stock analysis than broad brush sector positioning. In practice, this means that in the near time there are very clear and understandable dispersions in the performance of corporates. After all, it is information technology companies that have eased the path of life under lockdown with solutions for the new “work from home” culture and the requirement for continued “social distancing” which has accelerated the move to online services.

Not all technology firms are winners

That said, not all tech is flourishing in the midst of the pandemic. Technology companies which rely on physical interaction with customers for the fulfilment of services have faced a more challenging backdrop and uncertain future (this includes many pre-IPO businesses such as flexible shared office space provider, WeWork). These are so called “tech companies” operating in traditional consumer services and therefore still vulnerable to a collapse in consumer demand. History tells us that incumbent technology firms also need to be aware of the risk from ever-changing technological advancements. Note the cautionary tales of pioneering internet players Alta Vista (eventually acquired by Yahoo) and Netscape (acquired by AOL), both responsible for important developments in the internet, both eclipsed by the arrival of Google and Internet Explorer, respectively. This highlights the importance of having good fund managers picking the right stocks.

New industries versus old industries

You may think that these discussions would preclude managers of strategies with a naturally lower weighting to technology sectors (e.g. the UK equity market). It doesn’t. In fact, this is a market where not only can you find innovative businesses plugged into the inevitable technological changes in our lives, but it is also a market where many older industries feature prominently (e.g. oil majors, mining and traditional financials) and it is really important to understand where they are positioning themselves against the tidal wave of technological change. Those businesses which do not adapt will be left behind as the global consumer increasingly moves towards the adoption of online products and services.

What does this mean for investors?

Well, there are both direct and indirect ways in which you can gain exposure to these themes. There are the outright technology stocks, which have delivered market leading performance this year and as a collective have become a much more significant part of global markets (particularly the US equity market). However, fund managers should also be analysing those companies outside of the technology sector where there are opportunities to profit from technological advances within more traditional industries which will enable them to gain market share and industry advantage.

It is equally important to know that your fund managers are asking the difficult questions to the management of all businesses that are at risk of value destruction from these disruptive forces. This may see some businesses and industries that were hitherto considered steady growing businesses with defensive qualities lose their market leadership.

Risks to the technology sector

At the same time, investors should remember that the rally that we have seen in technology stocks may not continue unabated. There may be periods of short-term volatility prompted by a shift in market sentiment based on valuations or a change in the regulatory outlook for large tech corporations. Therefore, we must consider these risk factors when determining a suitable level of exposure to the sector. The milestone hit by Apple last week when the company’s market cap reached $2trn, gives an indication of the lofty valuations attached to some of these companies, particularly the FAANG companies (Facebook, Apple, Amazon, Netflix and Google) in the US. These tech giants now play a significant part in driving the direction of US equity markets.

The Five Wealth approach

At Five Wealth we take account of these structural trends and consider the shorter-term risks to valuations. Whilst we don’t try to “time the market”, we do seek to ensure our clients have exposure to these themes at a level which is appropriate to an individual’s risk tolerance and in keeping with their overall investment objectives. At the same time, we challenge the fund managers of the underlying strategies in your portfolio to ensure they are taking the necessary steps to avoid the casualties of this seismic shift in our way of life. Having had many of these conversations in recent weeks and months, we believe that the fund managers we recommend are asking the right questions and making considered changes to their portfolios that reflect these factors.

If you have any questions or would like to discuss this in more detail, please do contact your adviser.

The value of your investment (and any income from them) can go down as well as up and you may not get back the full amount you invested. Past performance is not a reliable indicator of future performance