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FSA pulls warning out of its hat over &#39magic circle&#39

The AITC and fund managers have been handed an ultimatum by the FSA to clean up the investment trust industry within six months or face action by the regulator.

The deadline, which was imposed by FSA managing director John Tiner as he testified before the Treasury Select Committee last week, came as the AITC revealed that up to a third of split-cap investment trusts may pay out at best only minimal returns.

The warning of a clampdown attracted immediate support from Labour chairman of the Treasury select committee John McFall and Conservative MP Michael Fallon but was met with strong resistance from the most heavily implicated fund managers.

Aberdeen Asset Management, which it admits that nine of its 18 split-caps are in distress, has hit back the hardest. It argues that the disclosure of holdings, which has been threatened by the FSA, should be voluntary as statutory regulation could hinder market forces.

Sales and marketing director Gary Marshall says: “You could have situations where a trust is liquidating assets to create cash as it winds up. Anyone would be able to see how much cash it needs to raise and which stocks are about to hit the market, which will enable the market-makers to move against the trust. The FSA wants to improve things for investors but forced disclosure would just put them at a disadvantage.”

Marshall claims there are many other examples of how statutory disclosure could work to the detriment of investors but is quick to point out that Aberdeen is fully behind the voluntary regime the regulator has given the AITC six months to develop.

Nevertheless, Aberdeen&#39s argument against statutory regulation does not wash with many IFAs.

Bates Investment head of research James Dalby says: “Aberdeen has a point but market-makers will be aware of things like stock holdings anyway. If all the companies co-operated with the AITC, regulation would not be necessary but it was not getting 100 per cent support from fund managers. The FSA warning should ensure that it does.”

The AITC says it hopes to meet the six-month deadline, mainly because support from investment companies has allowed it to make significant strides in creating a database with comprehensive holdings information. Communications director Annabel Brodie-Smith says: “We are well on the way. We have completed the initial stages of collecting data – mainly information on trusts&#39 portfolios, cash and debt positions – which the team is currently working on building into a database. We have had strong co-operation and hope that will enable us to meet the FSA&#39s demand.”

The database will give the AITC a risk measurement tool which online investors will be able to access to investigate the exact composition of almost every trust. It has had a similar program in place for some time, which displays all member trusts&#39 holdings above 0.5 per cent – lower than the statutory obligation of 3 per cent which the FSA is threatening to lower if the deadline expires.

Even if the AITC fails to complete the project in time and statutory regulation comes into force, the fact remains that damage to the industry has already been done. Companies such as Aberdeen may refuse to accept responsibility for the split-cap sector&#39s woes – and chief executive Martin Gilbert declined the Treasury Select Committee&#39s invitation to apologise – but there is little doubt that their investment decisions have badly harmed the market.

Plan Invest joint managing director Mike Owen says: “It is not as simple as blaming the market. All the companies in the so-called magic circle – Aberdeen, Exeter, BFS and so on – need to take more responsibility for what has happened. They are struggling to wriggle out of it but they should stop trying to pass the buck because much of this was down to their own errors and complacency.”

Many IFAs are keen to point out that there are a number of high-quality splits which invested sensibly and have performed well but may now be unlikely to attract investors who have put off by the cloud of negativity engulfing the sector. Even some private-client fund managers, many of which have been burned by investing in the poorer splits, are unhappy that the superior trusts are being dragged down despite their performance not being in question.

Principal Investment Management head of investment Alan Beany says: “The effect of what has happened with zero and income shares spreads far wider than the magic circle funds. It is unfortunate that those that have their merits have been tarred with the same brush as those that have been incestuous in their behaviour.”

Nevertheless, the preponderance of such views has not stopped Hargreaves Lansdown pulling out of the splits market although the move is perhaps not as significant as its decision to stop selling with-profits.

Yet there is a feeling in the industry that the FSA could be looking to pin the blame for misselling on advisers as it may have little scope to chase the companies which created and marketed the splits.

By issuing the warning, the regulator undoubtedly wants to be seen to be cracking down. But its decision to give the AITC time to improve matters perhaps goes to show it is not only the industry which believes it is already too late.

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