InvestmentsMar 12 2018

Fears Kids risk measure is misleading investors

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Fears Kids risk measure is misleading investors

The Association of Investment Companies has hit out at a requirement for investment trust key investor documents (Kids) to include a "summary risk indicator".

The trade body has warned this requirement could "mislead" investors.  

Under the European Packaged Retail Investment and Insurance Products (Priips) rules, Kids for investment trusts have to include a risk rating on a scale from one to seven, with seven being the riskiest.

But Mr Sayers said the measure is of volatility more than risk, and they should not be treated as if they were the same.

He said that following a period of exceptionally low volatility in recent years, there is potential for investors to be misled by the risk rating given to certain products.

Volatility is a measure of the propensity of share prices to move up or down, while risk is about the potential for permanent loss of capital.   

Mr Sayers cited the example of venture capital trusts (VCTs), which have been given a risk weighting of three by the Financial Conduct Authority, using a formula prescribed by the Priips rules.

According to the regulations, a product classified as a two or a three "is a low/medium-low risk class. This rates the potential losses from future performance at a low/medium-low level, and poor market conditions are very unlikely/unlikely to impact our capacity to pay you."

However the FCA has previously taken the stance that VCTs are high-risk, one some in the industry agree with.

Jason Hollands, managing director for business development and communications at wealth manager Tilney said: "A few years back VCTs were under threat of being categorised as sophisticated investments [by the FCA] that should not be marketed to retail investors.

"After engagement from the industry, they were exempted from this ban. However, firms operating in the VCT market, including ourselves, need to take care to filter who receives details of VCT offers and to clearly flag that due to the illiquid nature of the underlying investments they should be regarded as high risk."

He added that given the FCA’s historic view of VCTs, it is ironic the methodology used to measure the risk of the assets now is essentially a measure of volatility.

Mr Hollands said VCTs can appear to be a less volatile investment because they usually invest in unlisted assets, so there isn’t the daily price movements that occur in funds that invest in quoted assets.

This is also true of investment products that invest in infrastructure or other private businesses.

The FCA declined to comment on whether the risk indicator could mislead” investors but the watchdog has previously told product providers they have the flexibility to include information that explains the risk weighting.

But Mr Sayers said it is reasonable for an investor to rely on the risk summary, given the prominence of it in the Kid.

Mr Sayers said while he is starting to understand what clarifications his members are allowed to make to the documents, the risk weighting cannot be changed.

Concern has been raised about the impact of the simplified risk rating on investors' views of other investments.

David Thomas, chief executive of fund manager Seneca, said government bonds are traditionally viewed as being lower volatility investments, but given the valuations at which those assets currently trade, his firm thinks there is a substantial chance of loss of capital if the assets are held to maturity.

The risk measure used in the Kid cannot reflect this, he said.

John Kay, a professor at the London School of Economics and director of the £6.9bn Scottish Mortgage investment trust, told FTAdviser's sister title the Financial Times, investors should "burn" the Kid.

He pleaded with private investors: "Please, please, do not Google or download this document, and if you have received a hard copy, burn it before reading. Above all, keep it out of the hands of widows and orphans."

A veteran investment trust manager, who asked not to be named, said many fund managers feel the risk measures they have to comply with underestimate the risks.

He said he will try to provide additional information outside of the Kid to explain the true level of risk in his fund, but called for the FCA to change course.

david.thorpe@ft.com