Exactly how sophisticated are most investors? This may sound like a strange question, but I am moved to ask it after reading an article by Apfa senior policy adviser Caroline Escott, in which she proposes, yet again, a product levy to help meet claims on the Financial Services Compensation Scheme.
Escott’s article in last week’s Money Marketing goes further. She argues it is also time the amounts paid out in compensation – 100 per cent up to £50,000 of a claim – should be revised downwards and restricted to a percentage above a much lower £30,000 limit.
“Investment is not without risk and consumers must bear some responsibility for their decisions,” she suggests. A cap along the lines Escott recommends would not only “reduce the FSCS bill [but] also create more engaged customers”.
I will come back to the cap in a while. But first, let’s look at Escott’s product levy proposal. One thing it potentially has going for it is the suggestion the product levy should involve a “small surcharge for different product categories, depending on the risk of the product”.
Tied to a “white list” of products more appropriate for retail investors, with a much lower levy, this might help avoid cross-subsidies whereby cautious investors bail out those who choose riskier investments. Escott adds it “might even deter investors from investing in products that are not suitable for them”.
What is interesting about this argument is Escott approaches it from the perspective that it is investors who should be “deterred” and not advisers.
On the contrary, my own experience of most investors, going back to the question raised at start of this column, is they are for the most part unsophisticated, ignorant of the risks attached to particular investments and heavily reliant on the advice they receive from those they come into contact with.
All the evidence supports this view. Yes, there are some experienced investors and they lose money. But actually, the majority of clients are anything but sophisticated.
Last year, the Daily Telegraph identified up to £4bn of UK investors’ cash tied up in funds closed since 2009. Thirteen funds were suspended, meaning investors cannot withdraw their money at all.
According to the Telegraph, several of these funds – including Centurion Defined Return, Life Settlements and Argent, EEA Life Settlements and Managing Partners Traded Policies – invested in “death bonds”. The funds themselves supposedly offered secure, “low risk” returns.
“I would love to see what would happen if the adviser is told that given the risk profile of a particular class of investment, she or he will have to pay a massive upfront levy on that asset”
Keydata, which many advisers have distinctly unhappy memories of following the huge FSCS compensation levies they had to stump up, is another case in point. This was another death bond fund.
Savers were told HSBC was overseeing trading in the insurance contracts. In reality, huge chunks of money went into a US hedge fund. Again, all the evidence gathered subsequently points to thousands of punters with little or no clue of what they were getting into and heavily reliant on what they were told by their advisers.
Then there is the latest likely contender for a massive FSCS compensation bill, the Axiom Legal Financing fund, which vacuumed up almost £120m in funds before being suspended in 2012.
Axiom lent money to legal firms engaged in no-win, no-fee agreements. Only £12m was recovered from that black hole, of which barely £2.5m is available to pay back to investors after legal and other fees.
In one story I have seen, sources close to the investigation aimed at tracking down the money say while some advisers used Axiom as an opportunity to diversify a small minority of assets in a high-risk fund, others “put their clients’ whole life savings in to it”.
Underlying all these examples is one basic story: unsophisticated investors believe their advisers, who tell them these investments are low risk. They then turn out not to be.
Faced with that evidence, why on earth is Escott asking for investors to bear the burden of that astonishingly bad advice and not those who gave it to them?
If there is an argument to be made for a product levy in respect of investments – and for that levy to be risk-related – the person paying it should be the adviser, not the client.
I would love to see what would happen if the adviser is told that given the risk profile of a particular class of investment, she or he will have to pay a massive upfront FSCS levy on that asset. My guess is it would make most advisers think carefully before punting the latest crackpot scheme to clients.
What is also interesting about Escott’s proposal is that of reducing the £50,000 limit per investment firm. I have come across cases where as a result of demonstrably poor advice from an IFA, a client lost hundreds of thousands of pounds. Again, this was supposed to be a limited risk investment. The client complained, but was then limited to a £50,000 FSCS payout after the IFA went into default.
Yet Escott wants to reduce the £50,000 limit even further. At a time of such limited trust by most punters towards the financial industry, here is yet another wonderful example of positive and proactive consumer PR by Afpa. Not.
Nic Cicutti can be contacted at firstname.lastname@example.org