'Double dipping' is a catchy term
AJ Bell and State Street had different tactics for extra cash
Last Thursday, the investment platform AJ Bell reported sparkly results, including a 50% increase in profits. Analysts were quick to point this was mostly down to a surge in ‘ad valorem’ fees. Ad what?
Ad valorem fees are reoccurring administrative and interest fees, and AJ Bell saw a 60% uptick in them this year. But there was more:
AJ Bell has been holding a ton of client cash, most of it belonging to retail investors. Unlike professional investors, which tend to hold relatively little cash, the platform’s retail clients hold 13.3% of their assets in cash – a total of £3bn. (Total cash held by B2B clients was £1.7bn, so no small fry either.)
Even cash earns interest, and some of that gets passed back to the client. There’s always a spread, the company making just a little bit more than it gives back. It’s called ‘double-dipping’, which is a wonderfully evocative term, because the company effectively gets paid twice: once in fees, then again in interest.
But for years and years nobody cared, because rates were close to zero. Once interest rates did start rising, though, they became not zero at all. Suddenly, AJ Bell was earning a very healthy risk-free interest rate on a ton of cash – and it didn’t need to give it to anyone.
If you’re a company in that position, what should you do? Well, some things you know for sure:
For one, you like money, so you’d like to keep this going for as long as you can. Not just for the bottom line, but because it offers some wiggle room to cut fees elsewhere.
Two, you’re a public company, so analysts are going to notice. Three, you’re a financial services company, so eventually a regulator is going to come poking around. And when they do, you’re going to come out looking like the bad guy, because ‘double-dipping’ is such a wonderfully evocative term.
AJ Bell’s strategy was to just keep going until the FCA told it to knock it off.
That day came yesterday, when the FCA made a big splash about its concern over double-dipping, and told firms they have until 29 February 2024 to stop.
So today, AJ Bell announced it was raising interest on cash and also cutting costs on trading fees. Since it waited until the FCA intervened, it came out as doing so because it was slapped on the wrist.
Interestingly, last month another money-manager played near identical cards very differently:
Over at the ETF space, providers aren’t holding a lot of client cash. But they are holding lots and lots of shares, which they buy when clients invest. And they can earn extra interest on those shares, through the practice of securities lending.
Just like platforms, they’re not obliged to pass those excess earnings to clients. Just like platforms, they like the extra money. Just like platforms many of the large ETF providers are listed companies. What do they do?
On October 23rd, State Street Global Advisors (SSGA) chopped the total expense ratio on its S&P 500 ETF (SPY5) from 0.09% to 0.03%, making it Europe’s new lowest-fee S&P 500 ETF.
The SPY5 fee cut came after the ETF became one of 67 added to SSGA’s securities lending program.
And using this had the desired effect: in the following four weeks, SPY5 saw $1.2bn of inflows. For context, in the entire year up until that point, total inflows were $38m. Big difference.
Obviously, retail investors don’t switch platforms in response to fee cuts quite so swiftly as managers replace an index tracker. It’s highly likely that AJ Bell made the right business decision in waiting to be scolded by the FCA.
But ultimately it did end up using this money to make its products cheaper. SSGA did it before getting scolded, ended up earning a ton of good publicity, beat the competition, and gained quite a bit of new revenue.
Also happening
The City of London is hustling across the pond
The City of London Corporation is opening two offices in the US, in New York and Washington DC. The flowery release talked about wanting to “build on the already close relationship" between London and NYC. More like, setting up your shop on competition's turf:
The number of applications to list on the London Stock Exchange (LSE) has fallen to its lowest level in at least six years, and the Square Mile is struggling to attract new IPOs.
A big blow came last week when London-based commodities broker Marex filed for a New York IPO, after having attempted to list on the London Stock Exchange in 2021, and pulling back due to market volatility .
Its targeted valuation this time around is set to be between $2.2bn and $2.8bn, which is three to four times of what its goal was two years ago. In general, companies now believe they can score much higher valuations in the US. (Which is why this week's meeting between the LSE and Shein - as it’s looking to raise about $66bn - is unlikely to amount to much.)
All these companies are heading to NY to talk with the NYSE and the NASDAQ; wouldn't it be handy if the LSE has some sort of presence around the corner? Especially for the non-US companies:
Since 2019, 25% of the LSE’s IPOs have been by companies incorporated outside of the UK, compared with 19% of IPOs on the NYSE being by companies incorporated outside of the US. Always play to your strengths.
Nice brochures are expensive
Speaking of IPOs, some fun revelations on the business of producing IPO prospectuses. Arm Holdings and other companies are spending over $900,000 on these documents, even though technically the SEC stopped requiring print copies in 2005.
The market appears to have been cornered by Donnelley Financial Solutions, which has managed around 70% of sizable US IPOs in the past six years. Their services include formatting, which is not to be sniffed at:
I just learned that the term “bulge-bracket bank,” comes from the formatting requirements, whereby the underwriter names are listed in the biggest font size.
Hiscox brags about its AI
Hiscox announced it has teamed up with Google to create an AI model that automates the core underwriting process for specialist risks. It said it conducted a successful trial for automating the underwriting of a property sabotage and terrorism policy (apparently it's a thing) and announced plans to go live with the model in the second half of 2024.
For one, do you remember when was the last time IT departments managed to score headlines? In Hiscox's case, the AI digests the draft contract provided by the broker. It then passed the information to an existing, non-sexy system, to determine whether Hiscox will take on the risk.
For another, was the eagerness to put it into day-to-day work. It's a new use case - Hiscox made sure to stress no one's done it before. Nonetheless, Kate Markham, the chief executive of Hiscox’s London market division, said:
“The big question for us is: do we go (for) one line of business or do we try and drop this capability across multiple lines of business — which I think is our preference.”
Again, when was the last time you saw anything in IT work instantly?
I don't mean to pick on Hiscox here, but it does seem that "doing AI" is as much a story about marketing as it is about operations.
Treasure Corner
ESG has not been having a great year. Not sure this next bit will make 2024 any better, but it is instructive about marketing ESG funds.
Apparently, greenwashing funds attract similar flows as funds that are truly committed to ESG, suggesting investors can’t tell the difference.
This comes directly from a 2022 study, titled Discretionary Information in ESG Investing: A Text Analysis of Mutual Fund Prospectuses.
The researches compared the strategy descriptions found in fund prospectuses to these funds’ holdings.
First, they measured how much its holdings were “ESG” (based on analytics from several providers.)
Then, they measured how much the fund talks about ESG investments
Finally, they measured the discrepancy between the two.
Their definition of greenwashing is fair: funds that are in the top 5% in how much they talk about ESG, but that their ESG holdings are below the median.
Here’s what they found:
First, funds that talked more about ESG got more flows. The effect is more pronounced for flows coming institutional investors.
Second, the readability of the ESG text had positive, significant effect on fund flows. (Readability scores consider two factors: sentence length, and how many ‘big words’ are being used.)
Finally, investors direct their flows to funds that talk about investing in ESG, regardless of whether these funds actually invest in ESG stocks…
It bears repeating: According to their analysis, flows respond more to the ESG content of fund prospectuses rather than to funds’ actual portfolios.