If someone told you Venture Capital Trusts (VCTs) had the lowest risk rating of all the AIC’s member investment companies you’d think they were pulling your leg. You’d have a good laugh about it and then move on. But unbelievably this is exactly what the new European regulatory disclosure, the Key Information Document (shortened to KID) reveals. VCTs invest in small, higher-risk businesses but have the lowest average Summary Risk Indicator of the AIC’s membership, namely 3.4 on a scale of 1 to 7, with 7 being the highest risk.
It doesn’t improve when I tell you around a third of investment company KIDs (129 companies) have a Summary Risk Indicator of 3, which must be described as ‘medium-low’ risk. And even worse, nine investment companies have a Summary Risk Indicator of 2 (which has to be described as ‘low risk’).
Double dutch
Open-ended funds do not have to produce this information on the same basis as investment companies until 2020 but open-ended funds do produce a Key Investor Information Document (KIID) which includes a Summary Risk and Reward Indicator (SRRI). Yes – this is all nice and confusing – a KIID not a KID and an SRRI not an SRI. It’s sounding like double Dutch. Despite these similar titles and being presented in a similar fashion the methodologies for the two documents (KID and KIID) are completely different. It’s highly likely that private investors will use both documents to make investment decisions not realising the data is not comparable.
We looked at the Summary Risk and Reward Indicator for open-ended funds investing in equities which was 5.1. The equivalent average Summary Risk Indicator for investment companies investing in equities was 4.0. So private investors are being given the impression that investment companies are significantly less risky than open-ended funds.
Looking at the performance scenarios, the KID data is again alarming. In the ‘moderate’ performance scenario, 42 investment companies indicate future possible returns of more than 20% per year – not sounding very moderate to me. In the ‘unfavourable’ performance scenario, 45 investment companies indicate future returns of more than 10% which clearly makes no sense at all.
This KID data is encouraging private investors to buy high and sell low, a classic mistake that less experienced investors make. KIDs suggest after a sustained bull market, investors will get higher investment returns in the future and after a sustained bear market, investors will get lower future returns.
The regulators
The FCA has said investment companies can add some additional context on the future performance scenarios if they feel the performance disclosures are misleading. This is welcome news but demonstrates the flaws in this performance methodology. The FCA needs to take steps to stop the KIDs being more widely distributed than necessary.
We believe data providers and platforms should not be able to extract individual figures from the KID and should only show the KID document in full. The FCA should also make it clear to private investors that investment company KID disclosures are calculated on a different methodology to KIIDs for open-ended funds.
This is all highly concerning.
Investment company KIDs are misleading investors but investment companies and their managers have to produce them under European regulation. Every private investor has to tick the box to say they’ve seen the KID before trading on any direct platform and they have to be available on platforms.
The AIC’s Chief Executive, Ian Sayers, said on KIDs: “I have heard people say that KIDs are not worth the paper they are printed on. Unfortunately, in some cases, it is even worse than this.”
I think this sums up KIDs. I’d like to say you couldn’t make this situation up but I’d be KIDding.
