The publication of Key Information Documents (KIDs) has prompted a widespread negative response in the investment community, with large numbers of fund managers criticising the documents. More recently the Chief Executive of the Financial Conduct Authority (FCA), Andrew Bailey, stated his concerns.
I want to be clear that I am concerned about PRIIPsAndrew Bailey, Chief Executive of the FCA
He referenced the lack of context conveyed by KIDs (the disclosure requirements for the new PRIIPs regulation), concerns over performance projections, and the possibility that such regulation is damaging the industry. We think that his concerns are valid having reviewed a large sample of KIDs published for VCTs and EIS products, in addition to interviewing a number of tax-advantaged managers. Our Market survey highlights the differences in risk scores and the wide variance in the performance projections presented for VCT and EIS products. We believe that this is very likely to create confusion for investors assessing tax-advantaged products; for purely technical reasons, VCTs appear to be higher returning and much lower risk than EIS products.
There is no easy way to divide the retail investment landscape
The PRIIPs regulation divides the retail investment landscape into four distinct categories, with the categorisation of a product determining the way in which its KID is produced. Despite PRIIPs setting out detailed (and in parts restrictive) regulations, there is still some debate on how certain retail products could be categorised, and by extension if their KIDs are appropriate. This is particularly relevant within the tax-advantaged investment space, where VCTs and EIS products have been placed in different categories, despite many of them sharing very similar underlying investments.
Past performance does not guarantee future returns
There are many reasons why past performance may form a poor predictor of future returns, however products are obliged to present performance predictions based on past returns. While this step alone is problematic, the situation is compounded by the short historical period that most products base their estimates upon, this typically being two to five years. The ongoing bull market means that even those products that have used data for a longer time window still publish highly optimistic estimations of returns.
A single risk score is not informative
PRIIPs attempts to solve the problem of comparing the risk of very different products by collapsing the multitude of risks that could apply to investment products into a single number. While this certainly allows for a simple comparison, it does little to indicate in which circumstances risks would materialise or a product is likely to have low returns. Additionally, a single number provides no context with which an investor or adviser can determine if a product is suitable as part of a portfolio. Based on the results of our survey, we are concerned that some risk scores are potentially misleading. We have seen cases of private equity products receiving the same risk rating as diversified (investment grade) bond funds, which is likely to confuse investors.
Performance figures are not easy to compare
A KID contains an estimate of a product’s performance across a range of scenarios and holding periods. While this treatment may appear comprehensive, the reality is that investors are given no indication of what the performance scenarios correspond to, making the figures provided abstract and hard to relate to a real world scenario. Furthermore, some products present performance estimates based on statistical modelling of historical returns, while others base performance estimates on the manager’s best guess. This situation can only lead to confusion for an investor trying to make a sensible comparison between products.
KIDs do not provide enough context to compare investments
Investment decisions require greater clarity over the strategy, risks, and potential benefits of a given product. The KID leaves little room for explanatory notes or an ability to highlight information that could, in isolation, be misleading or confusing for investors. Further disclosures would certainly be helpful, particularly in the KIDs of tax-advantaged products as they make large numbers of illiquid investments, are likely to be difficult to exit, and are often outside the comfort zone of investors and even many advisers.
In our recent analytical report on KIDs, we take a more detailed look at the challenges of providing standardised documents to investors. The report then turns to an analysis of published KIDs within the tax-advantaged sector, discussing the risk and return information currently provided to investors, managers’ opinions on the current situation, and what investors should bear in mind when examining KIDs.