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Don&#39t ignore warning signs

IFAs and product providers have come under fire for marketing zero-dividend preference shares as safe investments. With the current turmoil in the splitcapital investment trust arena, are you still happy to recommend the use of zeros to meet deferred financial commitments?

Richard Craven: Very much so and, in my view, IFAs are far from being at fault for overstating the safety of these investment types. I feel it is far more a point to be addressed by the trade body representing the organisations issuing these investment types.

Much has been made of the historic nil default rate on these share classes and, while it is certainly an indicator as to the risk rating, I think that most IFAs with whom we have contact are very diligent in terms of the application of appropriate risk warnings. I do not think this is the case in respect of the high-profile advertising surrounding the sector.

Philippa Gee: There will always be certain investments that have a period of being in vogue and the moment we reach a crescendo of positivity is the time its downfall seems to be just around the corner. The important point is that, for a specific type of investor this asset can be suitable. However, it is not a case of one shoe fits all and that is where the recent problems have arisen.

The issue of risk is also imperative. What investment could be classified as risk-free over all time periods? There are obvious concerns over specific issues. However, the fundamental advantages remain for the right investor.

Andrew Merricks: Yet again, the investment industry has shot itself in the foot. Having used zeros for years, I became increasingly nervous as the “Magic Circle” gained influence within the sector and, through its antics, kept raising the bar of risk acceptability.

There has always been more spilt crap than split cap with this lot and now we are all suffering. I could not believe one launch presentation, which was frankly misleading to the IFAs present, who were generally inexperienced in investment trusts. Personally, I will continue to use zeros as I have always done – selectively and with the knowledge of how they are structured.

Several high-profile firms are launching mid-cap funds this winter, including the likes of New Star and Old Mutual. Do you think there will be demand for such funds and what place would mid-cap funds play in your clients&#39 portfolios?

Richard Craven: I do not think that we, as discount brokers, would expect to see a dramatic degree of public interest in this sub-sector. However, the profile of New Star will attract media coverage and, therefore, from our discount operation point of view, this will translate to business. In respect of our advisory division, I am sure that mid-cap funds will make up an element of many portfolios that we operate and I especially feel the growth potential and relative high capitalisation of the sector will prove attractive to some of our pensioner trustee clients when realigning positions.

Philippa Gee: A lesson learnt by many investors over the last 18 months is the importance of maintaining a properly constructed portfolio rather than over-relying on one area. With many existing holdings having a large or small-cap bias, there is an obvious gap which will be filled by these new funds. The concern is that first-time investors may opt for these as a starting point and the higher volatility combined with the risk involved with concentrated portfolios may not go hand in hand with their requirements. Nevertheless, in the right conditions, these funds should be worth consideration and the timing could prove prudent.

Andrew Merricks: I have always been surprised that there have not been more mid-cap funds than there are. I think it is important to have a good choice of mid-cap funds to choose from as it is a sector which, together with large cap and small cap, takes its turn as the place to be. This will become more prevalent as the promotion and relegation of issues to and from the FTSE 100 affects an increasing number of stocks.

If you are truly an active fund manager, there must be rich pickings towards the upper end of the mid-cap range, with trackers being ready-made buyers and sellers. However, whether there will be demand for them is another question. I hope so but I hope that multi-cap funds continue to be launched too. Make the fund manager work for their bonus.

Norwich Union Investment Funds is to concentrate its efforts on the Morley Fund Management brand in a move which will distance it from its traditional Cat-mark range. Do you welcome the firm&#39s refocus?

Richard Craven: Norwich Union is one of the few life insurers which have successfully entered the fund management arena outside regular life-wrapped packages and I believe there is much to be said for the concentration of efforts within a sector where it has made its niche.

The retail fund management world is, of course, full of big egos, big past performance claims, and extremely big marketing budgets and, unless NU is prepared to throw significant resources into elevating the Morley brand, I feel the current market leaders will have little to fear. I am quite curious as to the reasoning behind this corporate decision as, without question, NU has carved out a successful niche, albeit at the lower-margin end of the market.

Philippa Gee: With the pressure on prices, investment houses are looking at ways to sustain business profitability and the answer may not be through offering all products, especially at the lower end of the charge scale. However, investors are becoming more critical over initial and ongoing charges and the value derived from them. There has to be proof of active management as well as competitive returns to justify the cost.

Moving from the brand of a big bancassurer is a positive change and the association of strong fund management can be more easily emphasised. Therefore, this corporate move is encouraging.

Andrew Merricks: Insurance companies are the slappers of the fund management world, continually bed-hopping in search of the sugar daddy. To realign behind the name Morley is appropriate as this name is associated more with the Miss World competition than managing money in the general public&#39s eyes. If, having been backstage, Norwich Union now finds out that it does not pay to be Catty, all well and good. Anything that increases competition in the industry must be welcomed but the nagging doubt is how long it will be before its refocus needs refocusing again.

HBOS is bringing together the Halifax, Clerical Medical and Equitable Life investment operations to form a new giant asset management company. Do you believe it will be successful in its aspirations to become a top-five retail player?

Richard Craven: Quite possibly. However, I do not feel that this will be a reflection of any IFA or necessarily informed investor action. I think it will be a reflection of the extraordinary capabilities of distribution that will be available to this group in terms of its direct access to the banking public. It is rare indeed to see such a direct sales-orientated conglomeration being recommended by the average IFA, be it due to lack of access or, as is more normally the case, lack of reasoning to include such companies due to consistent underperformance. Notable exceptions, of course, include HSBC and Barclays Global.

Philippa Gee: If I had acquired Equitable and wanted to use it as a business-producing asset, I would have either to change its name altogether, which would mean a weak fresh start, or merge it with other stronger companies, which is where HBOS comes in. Business will be done.

However, the investing public are likely to question the validity of this proposition and, therefore, I do not envisage it making top-five status. The damage that one company has created for the whole industry is not a temporary issue and the story is far from over.

Andrew Merricks: It depends how it defines top five. If it is only after numbers, perhaps. If it is after top-five consistent performance, not a hope in hell. It will have to drop the Equitable brand pretty quickly and rely on the Clerical Medical name for public awareness while the good old Halifax just keeps marching on. It smacks of the Lloyds TSB/C&G/Scottish Widows&#39 approach which, quite frankly, has not set the world alight.

There will always be a market for the big banks but our experience is showing that the general public are getting fed up with this one-stop-shop approach for financial products and are seeking alternatives for particular strands of their financial planning. Mortgages are very cost-driven, Isas are more performance-driven. It is unlikely you will find the best of both under the same roof, unless you go to an IFA, of course.

Several firms have launched capital-protected funds over the past month, including Schroders and JP Morgan Fleming. Are you a supporter of such products?

Richard Craven: Very much so. There has been much comment on these fund types by the retail press, where the expensive nature of guarantees or relative participation rates in indices growth was criticised. But there is no such thing as a free lunch and, if an investor still wants to benefit from the potential growth that equities offer but cannot bring themselves to do so in an unprotected manner, I see absolutely nothing wrong with the concept of reduced participation in indices&#39 returns as long as this is clearly explained to the client.

It is hard to remember less certain times than we are in now, both in terms of the healthiness of underlying economies and the volatility of the world in general. I think if ever there is a period when guarantees will be well received, it is now.

Philippa Gee: There is a big difference between protected funds and bonds. The recent additions to the market are fixed-term bonds with a specific end date. These then come in two packages – income and growth, or growth only, and it is the second one that is the lesser evil.

The concern remains over what type of investor either of these actually suit. Someone who is averse to any sort of equity exposure would not have their requirements fulfilled and the investor seek-ing only limited exposure to equities could accomplish their goal better by structuring a portfolio with low equity allocation.

Andrew Merricks: I am a supporter, in that it is probably the best buy signal for non-capital-protected funds that we have had for a long time. As with most bandwagons, it is best to be off it when it has gained meaningful momentum. My experience of protected funds to date is that they do not work. The cost of the protection in a bull market is just too much.

If Schroders, JP Morgan Fleming et al can make one work effectively, great. It seems to me, though, that they underperform normal funds on the way up and, over a three-year period, on the way down. Not good value. Generally, capital-protected funds are for the providers and intermediaries to make some money during difficult periods. If, as an adviser, you are bearish on the market outlook, the client should stay in cash. If, taking a medium-term view, you are bullish, why offer protection?

Richard Craven, partner, HCF Partnership

Philippa Gee,investment strategist, Torquil Clark

Andrew Merricks, partner, Simpsons of Brighton


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