If you think more regulation is the answer, you are probably asking the wrong question. That is my firm belief after more than 30 years reporting on the rise and failures of statutory financial regulation – a period which, by no means coincidentally, saw Britain decline from a nation of savers into a country of debtors.
Now, as if fresh examples of the law of unintended consequences were needed, here come the KIDs or ‘key information documents’ all investment trusts are required to publish.
When plans for these were first aired about five years ago, it really was hard to see what could go wrong. The original idea was to provide standardised information about pooled funds to make it easier for investors to compare costs, risks and rewards on a like-for-like basis.
What’s not to like, as we probably didn’t say back then? With several different ways of attempting to measure how much of investors’ money sticks to managers’ shovels, it seemed an obvious improvement to make investment trusts and unit trusts, as well as other forms of pooled funds, present this important information in the same way.
Now, as if to demonstrate that there is no situation so bad that regulatory intervention cannot make it worse, the Financial Conduct Authority (FCA) has botched the birth of KIDs. Other Remoaners can try to blame Brussels but, for once, I am in complete agreement with the Brexiteers. This turkey was born in Canary Wharf, where FCA bureaucrats feather their nest.
The most obvious reason it won’t fly is that only investment trusts are being forced to publish the new standardised KIDs while unit trusts and other forms of pooled fund can continue to pick and choose for another two years. So investors seeking low-cost or high-value fund management must try to compare apples with pears for another 24 months. Doh!
Worse still, the basis on which these new KIDs must assess risks and rewards is potentially misleading. Charles Cade, head of research at Numis Securities, explained: ‘Unlike a typical fund factsheet, the KID is not allowed to include historic returns.
‘Instead, there is an illustration of the potential return under four performance scenarios - stress, unfavourable, moderate and favourable - over one, three and five years. However, these scenarios are inherently based on share price returns over the previous five years, a period that has seen strong market performance, narrowing discounts and falling volatility.
‘As a result, the scenarios often appear highly optimistic in our view. For instance, Scottish Mortgage [SMT] shows five-year returns of 23.1% per annum under the “moderate” scenario and 10.7% per annum under the “unfavourable” scenario.’
Even fund managers who must produce what look like highly flattering forecasts under the new KID rules are complaining about the risk of creating false expectations among investors which are destined for disappointment. One chairman of a multi-billion pound investment trust, who I won’t name, told me: ‘This is the next mis-selling scandal.’
Ian Sayers, head of the Association of Investment Companies, said: ‘I must be one of the few chief executives of a trade association who has been inundated with complaints from his members that a regulator is forcing them to overstate their performance and understate their risks.
‘But it is one of the happy features of the investment company sector that independent directors are more interested in presenting a fair picture than simply complying with rules.’
This might all sound rather technical, which may explain why it has not received much coverage in the mainstream media yet. That will change dramatically if risks and returns in future prove higher and lower than these KIDs lead investors to expect.
KIDs could turn nasty quicker than you can say: ‘Compensation and retrospective regulation’. What blame will the FCA accept for this scandal foretold? Sweet FA would be the way to bet.
Full disclosure: here is a complete list of Ian Cowie’s stock market investments. It is not financial advice nor is any recommendation implied.