EU document will not end labelling concerns, say groups

The Financial Services Authority (FSA) and the Investment Management Association (IMA) have voiced concern that some funds that carry an “absolute return” label are inaccurately des­cribed and could mislead investors, given that they do not guarantee positive gains.

Andy Maysey
Andy Maysey

Controversy over the label follows several high-profile cases in which fund labels such as cautious, balanced and active may have failed to convey all the risks associated with a fund’s underlying assets.

The introduction of the Key Inves­tor Information Document (KIID) in July is intended to clear up some of these potential confusions by means of a standardised approach to labelling.

But even though the document has been finalised, investment groups are worried that a unified system is both unrealistic and unlikely to come about through the KIID alone.

Concerns about labelling can be summarised by recent cases such as the one involving Barclays.

Barclays was ordered to pay a £7.7m penalty after the FSA found that its investment advice for the Aviva Global Balanced Income fund and the Global Cautious Income fund “did not refer to any of the risks nor the need for those risks to be clearly communicated to prospective customers”.

Research by Skandia has revealed that half of all Cautious Managed funds invest in alternative investment strategies, which some investors might not regard as cautious, including alternative assets, foreign exchange, futures, hedge funds, managed futures, private equity, structured products and reverse convertibles, which carry risks that are sometimes not adequately explained to investors.

”The present risk rating system is less effective than talking about risks”

The IMA has gone as far as to propose the Absolute Return peer group be split into two sectors, separating funds of one- and three-year duration.

Funds running for just 12 months would be disallowed from the Absolute Return sector on the basis that a year is not long enough to properly gauge the effectiveness of a fund’s performance.

Arguably, all of these fund labels may need a drastic overhaul if investors are fully to grasp their inherent risks.

The KIID is being introduced as part of the European Union’s Ucits IV directive. Replacing the simplified prospectus, it will employ a concrete two-page format which includes the fund’s objective, investment strategy and fee structure and measures volatility on a seven-point scale. (article continues below)

But investment groups are worried that the KIID will not prove effective enough in addressing the labelling question.

Andy Maysey, a senior adviser on retail distribution at the IMA, says that while the trade body fully supports the introduction of the KIID, the document could have benefited from further specifics. He says that although “the document was well supported by the consumer lobby and tested by the consumer … the display mechanics could potentially be adjusted to make it larger.” The present risk rating system is less effective than talking about risks, he says.

While it is hoped the KIID will go some way towards addressing labelling concerns, many investment groups are unconvinced enough to be sourcing independent means of risk assessment.

Skandia is the latest provider to warn there could be further cases resulting in FSA penalties.

Graham Bentley, the head of investment proposition at Skandia, says a standardised formula for illustrating risk would help to promote awareness and provide consistency.

Skandia has introduced its own risk assessment model. The Skandia Managed Fund Analyser enables advisers to identify the overall risk score of any managed fund as well as analyse the detailed asset ­allocation.

But these kinds of risk assessment tools carry their own problems. The FSA recently published a report indicating that “in-house”, or “off-the-shelf” tools are often not fit for purpose or “fail to mitigate a tool’s limitations within the suitability assessment”.

It seems there is little hope of anything like a uniform risk assessment tool, as a risk-profiling tool’s definition of cautious could be different from the risk generated in a “cautious” portfolio by an asset-allocation tool if they use different underlying assumptions.

Although the KIID may improve the present situation and make cases such as the recent Barclays one less frequent, there will still be a strong requirement for managers to focus on personal interaction with investors.

Re-labelling is a progressive move but initiatives such as risk tools cannot not be relied on in isolation. Investors will still have to be aware of the complete structure of their investments.