Risk indicators on official documents can vary deceptively between investment trusts and their sister funds, warns the AIC
When it comes to indicating the level of risk inherent in an investment trust and its ‘sister’ open-ended fund, the Key Information Documents (KIDs) introduced at the start of the year are tending to mislead investors.
The Association of Investment Companies (AIC) looked at 56 investment trust KIDs and then compared their Summary Risk Indicators to the equivalent indicators in the Key Investor Information Documents (KIIDs) produced by their sister funds.
A ‘sister’ fund is a fund which shares the same manager and overall investment strategy and has a significant overlap in terms of portfolio. Both KID and KIID indicators grade risk on a scale from 1 (low) to 7 (high), but they are calculated in different ways.
Given the existence of discounts and the possible use of gearing, investment trusts tend to be more volatile than their sister funds and should therefore have a higher risk indicator.
However, the research shows that none of the trusts analysed have a higher risk indicator than their sister funds, and the majority are indicated as being lower-risk than the sister fund.
Ian Sayers, chief executive of the AIC, says: ‘Imagine consumers choosing between an investment company and its sister open-ended fund. They have done their research, chosen an investment strategy and manager they like, so all they have to do is decide whether to buy the investment company or open-ended version.
‘The investment company KID is showing stellar returns in ‘moderate’ markets, and healthy returns even in ‘unfavourable’ markets. Prudent investors might then check to see whether these returns are being obtained at the price of much higher risk by comparing the risk indicators of the two funds. Imagine their delight to discover that they can have these fantastic returns with lower risk.’
But he adds: ‘Of course, this is all nonsense. It reflects the reckless decision to allow competing products to produce seemingly identical information but calculated on a different basis. Any suggestion that consumers will appreciate the subtle difference in methodology between the two risk indicators, when they are called virtually the same thing and presented in exactly the same way, is laughable.
‘I cannot remember a time when consumers, directors, managers, analysts, trade associations and media commentators were so united in their criticism of a piece of regulation. Only regulators appear to have failed to spot what is obvious to everyone else, that basing future projections of risk and performance on the recent past was doomed to failure, and so it has turned out.’
He argues that although a longer-term solution will need to be carried out at the European level, the FCA should take steps today to protect consumers. ‘A good start would be to acknowledge how bad this regulation is and then warn investors not to rely on these disclosures when making investment decisions.’
Charles Cade, head of investment companies research at Numis, says: ‘This doesn’t come as a surprise. In aggregate, we believe that the Summary Risk Indicators (SRIs) for the [investment trust] sector are in line with expectations. However, there are a number of anomalies reflecting the fact that calculation of the SRI relies heavily on historic volatility of a trust’s share price rather than the nature of the underlying assets. In our view, low historic volatility is sometimes a reflection of a lack of liquidity (or an insurance-style pay-off profile) rather than low risk.
‘We also hold concerns over the Performance Scenario data and the Fund Charges data. We believe the inclusion of finance costs in the charges data is misleading, and there are also significant differences in calculation methodology between trusts.
‘In summary, we agree with the AIC that the KIDs are extremely misleading for investors. The differences in calculation methodology from the KIIDs produced by open-ended funds also create confusion for investors.’