Few industries have grown more in status and stridency than investor protection. The edicts of the regulatory agencies pour forth, along with voluminous “must read” documents to be noted, acted on and kept on file. But despite their aura of authority and infallibility, how reliable are they? Can they be trusted as an informed assessment of risk for private investors, fund managers, analysts and independent financial advisers?
A fiery row has erupted over one of the most hyped documents in the regulatory armoury: Key Information Documents (KIDs). The rules are part of the European Union-packaged retail and insurance-based investment products directive introduced in January. They are intended as an essential guide to product risks across the universe of financial products.
But the Association of Investment Companies, the body representing the investment trust sector, has urged City watchdog the Financial Conduct Authority to issue an investor alert after its research showed controversial new KIDs routinely understate the risks of investment trusts and closed-end funds listed on the stock exchange.
John Kay, the economist and non-executive director of Scottish Mortgage Trust, has gone further. He has encouraged investors to “burn” the documents rather than read them, so outraged was he by the misleading forecast returns trusts were obliged to publish under three different market scenarios.
As the authoritative Investment Trust Insider website reported last week, the AIC compared the risk ratings of 56 investment companies with those of their “sister” open-ended funds which share the same fund manager and investment strategy. Although both types of investment fund grade their risk from one (low) to seven (high), the calculations they are required to use are different.
While investment trusts and companies now operate under KID rules as part of the EU packaged products directive, open-ended funds continue to comply with older and slightly different rules. The AIC contends that the co-existence of similar but different risk ratings for the two categories of collective investments has produced highly misleading results.
The trade body found none of the 56 investment companies had a higher risk indicator than their equivalent sister funds. This was in spite of their ability to gear (use borrowed money to boost returns) and the tendency for their shares to trade at a different price to their underlying assets. Both features are generally regarded as making investment trusts riskier but better-performing investments than open-ended funds, which cannot gear and whose shares cannot trade at discounts below or premiums above their asset values.
The AIC found only three of the investment companies in its study had the same risk indicator as their sister funds. Forty had a risk grade that was one lower than their equivalent fund while 13 were rated two grades lower than their open-ended sister, an assessment AIC chief executive Ian Sayers has described as a “nonsense… It reflects the reckless decision to allow competing products to produce seemingly identical information but calculated on a different basis.
“Any suggestion that consumers will appreciate the subtle difference in methodology between the two risk indicators, when they are called virtually the same thing and presented in exactly the same way, is laughable”.
Imagine if a hapless IFA or wealth manager was found to have dispensed advice in this way and the investor had complained about misleading guidance. Few epithets would have been spared to denounce the adviser.
This is not the first time the investment trust sector has had to challenge the EU’s regulatory treatment. A few years ago it had to mount a vigorous campaign against EU proposals to treat investment trusts as indistinguishable for regulatory purposes: a classic bureaucratic approach akin to treating oranges as identical to mushrooms.
The AIC has made clear it will not publish the flawed documents on its website. And the FCA has had to change tack. Chief executive Andrew Bailey, pictured, promised new proposals for the disclosure of investment costs and charges will be published this month.
Sayers said: “Though a longer-term solution will need to be carried out at the European level, the FCA should take steps today to protect consumers. A good start would be to acknowledge how bad this regulation is and then warn investors not to rely on these disclosures when making investment decisions.”