The FSA wants life companies to volunteer information about their past sales of structured products because it is worried that there will be a “fallout” when they mature. Do you think there are major concerns about these bonds failing to return capital? If you think there might be, is it the fault of IFAs, pro-viders or neither?
Scott: Provided that these investments are explained properly to clients, then the FSA need not worry about a “fallout”. However, given the current low levels of the markets, it is very likely that clients may not see a full return of initial capital. This is evident with the Scottish Mutual income bond seventh issue due to mature on October 11. This bond is linked to the Eurostoxx 50 index and Scottish Mutual is estimating that the capital return may only be 67 per cent of the original investment.
Merricks: Yes, I do think that there is a major concern as loads of these things are likely to fail. The providers have products to sell – that is their job. An IFA's job is to try to assess the quality of that product and its suitability for the client. Unfortunately, the quality of the product began to diminish about as rapidly their chances of meeting their criteria and IFAs should have spotted it.
I think that the original five-year straight FTSE 100-type funds were perfectly acceptable and no one could have foreseen the extent of what was to happen five years later. But when the indices against which returns were based became more obscure, timescales became shorter and baskets of shares began to be used with more conditions attached than an Iraq arms inspection, this should have told us something. You did not need to be Einstein to work out that these were riskier, regardless of what the literature told you.
Connolly: There are major concerns with regard to a big number of structured products, particularly those that run for a three-year rather than a five-year term. Over the course of the next 15 months, we will see a number of these products maturing whereby investor's initial capital will be seriously affected.
The reason for this crisis is simply down to the poor performance of the stockmarkets over the past 2.5 years. While it is easy to place the blame on IFAs or product providers, in most cases, this blame is not warranted. If IFAs have blatantly missold these products or product providers have not adequately failed to disclose the risks involved in their literature, then they must accept at least some the responsib-ility. Although in most cases investors will have been aware of the risks at outset, they simply did not expect the markets to perform so badly but then neither did anybody else.
Standard & Poor's recently said that index trackers are higher-risk investments than many people looking to avoid sector and stock-specific risk realise. Do you agree that there is a common misperception about these funds on a risk and performance basis?
Scott: Index-tracker funds attract varying degrees of risk depending on what index they follow. For example, a Nasdaq tracker, by its very nature, would be deemed a high-risk investment. Misperception will only apply if the product is not explained properly and generally an adviser should make the client aware of the components of the index which the fund manager is tracking.
Index trackers are moving targets and go against all investment rules. This is because the managers can be forced to buy stock at a high price when a new share enters the index and sell stock at a low price when a stock falls out the index. This does not make sense to us and we are not big fans of these investments. We have described index trackers in the past as “an asylum run by its inmates”.
Merricks: Definitely. It has been a soapbox of mine for a while now but people have been shovelled into these through the promotion of Catmarking, stakeholder and men in woolly jumpers at precisely the wrong time. Trackers work when momentum is with you and do not work when momentum is against you.
They are probably the best definition of a momentum investment there is and at the moment the trend is just short of vertical drop. I have always found it difficult to understand why anyone would prefer to buy something irrespective of quality but this is what tracker buyers do.
At a time when dividend yield is becoming ever more important, being locked in an index fund which does not pay you seems even more baffling. Why has it taken Standard & Poor's so long to state the obvious when most of us were saying this when Vodafone formed 12 per cent of the index?
Connolly: Many investors and, I am sure, some advisers, do not appreciate the risks inherent in tracker funds. The major UK indices offer very poor sector and stock diversification. This means the overall performance of the indices is dictated by the financial, oil and pharmaceutical sectors and is heavily influenced by just a handful of individual stocks. If these sectors or stocks perform badly, then the overall index return is likely to be poor.
The AITC has published research showing that war with Iraq and job insecurity are the main factors deterring more than a third of investors from re-entering stockmarkets. Have you found this to be the case with your clients or is it simply down to poor investment conditions? Are investors any more optimistic?
Scott: Most experienced investors know that the best time to invest is when the markets are at lower levels and the media are constantly quoting that the “world is coming to an end”. Our clients, although uncomfortable, are remaining in the markets and fully believe that they will recover in time. Furthermore, some of our clients are seizing the opportunity to invest further at these levels and statistics show that following a bear market, there will be a strong bull market and history shows that they could grow their investments by up to 40 per cent to 50 per cent relatively quickly from now when the markets do turn. This is clearly an investment opportunity.
Merricks: Presumably this is why Saddam Hussein has delayed making his Isa contribution this year. I suppose the other two-thirds are not re-entering the market because they have nothing left to re-enter with. Investors are not optimistic in the slightest and I fear that we have lost a whole generation of stockmarket investors. To be honest, why should they invest?
With the insurance industry net forced sellers of equities (despite what they say), where is the recovery coming from? Whether it is job security, Iraq, false accounting or simply the last quarter's statements, there are 101 reasons for investors to sit tight at the moment. All we need now is for the bloody Daleks to invade.
Connolly: Many of our clients were not investing into the equity markets prior to the Iraq situation as fears about job insecurity developed. Investors are very, very nervous. They were apprehensive before September 11 but events on that day took the last ounce of courage from many.
Since that time, they have been hit with one piece of bad news after another and with stockmarkets only moving in one direction. The Iraq situation and job insecurity are merely two more excuses in a long list why investors should not commit new money to the markets.
IFA SIS Group wants to recruit around 30 advisers to work in franchised financial advice departments it hopes to install in the offices of accountants and solicitors. One franchise is lik- ely to be a specialist investment department. Can you see clients of lawyers or accountants being inter-ested in such an in-house arrangement or do you think they would rather keep their affairs separate?
Scott: Most clients we have here are loyal to ourselves and have dealt with us for many years. In our experience, clients like to deal with different advisers for all their different requirements as opposed to a one-stop shop Jack of all trades.
Specialist advice is recognised and as such our clients will seek this from different professionals. Inevitably, lawyers and accountants will push their in-house IFA and perhaps even offer to reduce their fees to get an introduction. I would hope, however, that our clients will remain loyal as they know we offer good-quality impartial advice at a reasonable and fair cost.
Merricks: I think that it is a good idea. It is the type of thing that we have spoken to solicitors and accountants about ourselves. Like all businesses, if the client likes the service that he/she has received, they are likely to come back for more. One of the problems in the past is that solicitors and accountants have seen investment advice as easy and we all know it is not. So, in the same way as I go to a specialist conveyancer, I would certainly consider going to a specialist investment adviser within a legal or tax firm if it was not for job insecurity and war with Iraq, of course.
Connolly: Lawyer or accountant contacts are a potential business source which are not exploited by very many IFAs. In our experience, many clients like to keep their investment affairs separate but there are enough clients that would accept referrals from their lawyers, accountants or solicitors to make this a potentially profitable source of business.
What is more, the clients referred from these sources are likely to be high-net-worth clients, the sort which most financial advisers would like to attract. The key for the SIS Group must be to develop the right contacts. This is not an easy task but if they can achieve this, then they will have every opportunity to be successful.
Standard & Poor's has entered the multi-manager market by agreeing a deal with Schroders to provide a global fund of funds service. As S&P is an independent rating agency, do you have any concerns about it providing a panel of recommended products from which Schroders' investors will choose funds?
Scott: S&P is only one of the independent rating agencies that we consult. As an independent adviser, we still have the choice of all funds on the market and will provide recommendations to our clients based on other research. This, therefore, does not overly concern us as a company but we know that impartial advice is important and to remain whiter than white, this could impinge on S&P's creditability.
Merricks: The whisperers have been active for years questioning the independence of rating agencies, haven't they? I have not really got any concerns about them providing a panel of products for Schroders' investors to choose from. If Standard & Poor's and Schroders want to set up a deal between them, that is up to them. Presumably it is up to whoever uses their joint offering whether they do so or not, too.
Connolly: Standard & Poor's is a business whose aim is to make a profit. Yet, if it is to be seen as an independent source of information, it has to pay attention to its business activities. In some quarters, the impartiality of Standard & Poor's is already being questioned, with concerns circulating about the way some individual funds have been appraised. The proposed deal with Schroders may be helpful in meeting the objective of making a profit but Standard & Poor's will be seen to be taking another step away from being an impartial and independent agency.
David Scott, Financial consultant, Alan Steel Asset Management
Patrick Connolly, Director, Chartwell Investment Management
Andrew Merricks, Partner, Simpson of Brighton