An article by John Kay for the Financial Times reveals a nonsense in the Key Issue Document (KID) that is now mandatory for all funds. It raises a question mark over the competence of all those involved in its design and approval.
We are sympathetic to attempts to describe financial products in terms that are standard (and therefore allow comparison across products) and clear to less-knowledgeable retail investors. But the provisions for the treatment of risk revealed by John Kay’s article are a disgrace. The ignorance of real-life investment revealed despite many years' consultation and review is staggering. The connivance of the advice and fund management industries – who were presumably consulted – is shameful. If uncorrected the Document will lead to widespread consumer detriment, promote bad advice and bad funds at the expense of good ones and hamper attempts at consumer education.
We summarise:
• The KID equates ‘risk’ entirely with volatility. Academic work on volatility and investment rightly earned a number of Nobel prizes for shining an analytical light on a particular feature of investment risk, but there is no evidence that they thought that volatility told the whole story – or if they did they were wrong.
• Long-term investors who understand compound interest don’t fuss much about volatility except when approaching an age when they need to secure their lifestyle into the future; they fuss about Black Swans and long-tail risk and diversifying specific risk.
• It’s traders who fuss obsessively about volatility, together with all others who make their money out of it (corporate advisers, financial services, private equity, specialist fund managers).
• Breathtakingly, the KID compounds its misleading approach by specifying a precise calculation of ‘risk’ (i.e volatility) which projects the parameters of the last five years and applies them to the future. Did the designers somehow miss the sound caveat that is attached – by law – to all product pitches: ‘Past performance is no guide to expectations for the future’?
• We have enjoyed a period of unusually benign markets, in terms of both volatility and return. Forecasts naively based on this history will be idiotic. We can’t do better than quote two of Professor Kay’s examples:
- An investment in the Scottish Mortgage Investment Trust (a large general trust admittedly with a particular point of view), under a market scenario described as ‘moderate’ (word not defined), can be expected to return 20% per annum for the next five years;
- An investment in the Bitcoin XBT tracker fund under a ‘moderate’ scenario would be expected to earn 150% over one year.
This KID will allow bad advice to drive out good, encourage the wrong sort of funds and promote financial products designed to exploit its confusion. We ask that action be taken immediately to limit the damage. We also ask for an explanation of how this has happened, and particularly what consultations took place outside the narrow fields of government and the financial services industry. Finally this whole episode raises questions about the competence of financial education carried out under public auspices.
