Funds industry continues to be plagued by CDSC inefficiencies despite surge in funds______

Justin Christopher, Managing Director - Head of Asia

Standing out is vital in a crowded marketplace. This has led fund managers to focus on service and digital experiences while finding ways to reduce the cost of the fund as ways to get an edge on the competition.

The use of different charging mechanisms is not new, but it is another way to incentivise investors with lower fees if they hold the fund for a set duration, which can help to alleviate market volatility. In fact, the number of contingent deferred sales charge (CDSC) type funds has grown 98% since 2017 according to Lipper data.

B minus

In Taiwan there have been efforts by the regulator to incentivise the funds industry in a way that focused more on investor interests. This led to the jump in CDSC funds – commonly known as Class B Shares in Taiwan – available. However, according to Ignites Asia, fund managers felt the large scale ramp up of CDSC funds was unsustainable due of the advance fees they must pay from their capital.

What has yet to been discussed is the fact that processing CDSC funds can be a manual and convoluted process due to the need to capture more detail than normal. TAs have to keep what is effectively an additional book of record for sub-accounts, with the sub-accounts monitoring the subscriptions and share class migrations, so they can be tracked accurately. This investment experience stands in stark contrast to that of Class A fund shares, the market for which, at least in Taiwan, is almost wholly automated.

So, while it’s an area of growth and opportunity, it’s also an area dented by inefficiency. For those firms that can use technology to digitalise and automate aspects of everyday fund operations, there is a significant opportunity to generate alpha by improving the total expense ratio (TER) of a fund as well as the overall investor experience.

Many of the global TA systems used to process CDSCs, however, were designed over 20 years ago, with set processes. While they have worked, they are not designed to be as agile and flexible as they need to be for modern investor demands. This makes the ongoing monitoring of an investor’s status within the fund a difficult task, because these systems are unable to automatically ingest, process and track the data points required to determine the age of an investor’s holding and calculate the correct fee to be charged. Indeed, some fund managers have had to move away from their existing TA provider, or take up some of the manual work themselves to supplement their TA, who otherwise cannot support the CDSC process.

If something goes wrong – for example, the investor’s funds are not migrated at the right time or they are charged a fee they shouldn’t be – the work to identify all the transactional records, recalculate whether an exit fee should have been applied and actually come to resolution can take weeks or months. Firms not only bear the costs of using up the time of their TAs in understanding the level of the error and the associated costs, they also carry the reputational risk for these mistakes. These delays and additional charges strain the relationship between TAs, fund managers and distributors, and lead to investor dissatisfaction.

In addition, the largely manual nature of CDSC processing results in higher than necessary fund expenses. The additional work and resource requirements mean that TAs either have to absorb the cost, squeezing their margins, or set a higher fee to process the fund. This increases the TER of the fund, making it less appealing to investors who ultimately see this cost passed through to them.

Evolving the CDSC process

Fundamentally, the firm that truly automates the CDSC process can stand apart from the rest in terms of the accuracy and timeliness of their service while reaping the rewards of lower processing costs. Their risk teams will also be more content too.

Changing TA is not a priority for any fund manager. This is why technology firms are now in place. They have easy to plug-in solutions that fund managers and TAs can use without the cost and inconvenience posed by long-term transformation projects. This is how we designed Calastone CDSC. It can be deployed in its entirety, or more flexibly to help firms solve specific issues within their CDSC process.

It operates as a digitalised register, automatically capturing and digitally recording all the necessary CDSC information at the sub-account level, running the rate calculations and allowing for flexible rule applications across different funds. And, being part of our Distributed Market Infrastructure (DMI) Fund Services, it leverages the latest technologies so all the relevant data is available on demand.

The result is that fund firms can have a real-time view of the status of each investment and the relevant charges, ensuring that investor holdings roll-over at the right time and providing a clear audit trail. Moreover, the automatic calculation of exit fees should an investor redeem early avoids the chance of error or the wrong calculation methodology being used. This all works to lower the overall running costs and enhance fund profitability.

Making CDSC a competitive advantage

For fund managers and TAs, this sort of digitalisation is a major step forwards. It gives asset managers a digital, accurate and real-time view of investor holdings across periods and automates key activities such as roll overs and exit fee calculations. Similarly, transfer agents get to refocus their teams onto more pressing business priorities while avoiding the discrepancies that emerge when queries are logged, particularly in relation to exit fees. Meanwhile, distributors get to offer a superior investor experience as the chance of delays and errors are enormously reduced.

This is all the more important now, as retail investors are poised to become responsible for an estimated 62% of AUM globally by 2025, having been level with institutional investors a decade earlier, according to Oliver Wyman’s Wealth & Asset Management Report. And this will naturally mean an increase of AUM for CDSC funds. Firms that fail to review and update their processes risk being left behind. The winners will be those who secure the trust of the investor community – an increasingly rare commodity in today’s world.

Calastone Contingent Deferred Sales Charge (CDSC)

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