As fewer companies are coming to market at early stages of their development, private equity is becoming increasingly important to investors. Is access to private equity meeting the demands of your clients?
Carruthers: There is a limited supply of suitable private equity for smaller investors. We would generally use suitable small-cap funds where appropriate for many of these investors as well as venture capital trusts and occasionally enterprise investment schemes which tend to match the majority of retail investors’ needs.
Chadborn: If the assumption is correct that private equity investment is undertaken by specialist fund managers, then it would be fair to say that this type of investment would be unsuitable for the smaller investor unless they require some degree of adventurous or specialist market exposure.
The majority if IFAs would meet these clients’ needs by exposing them to traditionally higher-risk sectors of the market such as emerging markets or venture capital trusts. However, the returns from private equity investments can be impressive and should not be overlooked, particularly as they are generally less risky than VCTs. I think there is sufficient access available, particularly via fund of funds. This approach will gain greater diversification by investing across wider regions and geographic regions, reducing risk.
Modray: The introduction of extremely generous tax breaks on venture capital trusts makes them an attractive vehicle for accessing private equity. However, the risks can be high so it is vital to thoroughly research VCTs and their management teams before investing. I do have some concerns that too many fund management groups will try to jump on this bandwagon although most mainstream managers will focus on Aim shares rather than private equity. There are also a few reasonable investment trusts that invest in private equity, such as Kleinwort Capital and HG Capital if investors want to take this route.
Do you think fund managers are adequately disclosing the total cost of their funds? How much understanding do most IFAs have of TERs?
Carruthers: Yes, the majority of fund managers now do provide adequate disclosure of their TERs. In fact, it is becoming very difficult for the managers not to disclose the expenses associated with a fund in this highly regulated environment. We always use total expense ratios in our analysis of funds. However, it is one of many things that we consider and you have to remember when considering TERs that you get what you pay for. Just because a fund is cheap, it does not mean it is a good performer. Some of the best-performing funds have high TERs.
Chadborn: I do not think that the total cost of funds is being adequately disclosed but neither do I think this is necessarily a fault of the fund managers. Costs are not deliberately hidden, it is just that it is not a requirement for them to be fully disclosed by fund managers unless asked for. The costs are easy enough to find if you know where to look but if it is not a specific requirement to discuss with clients, then IFAs will not necessarily look for them.
I believe IFAs have a good understanding of the concept of TERs but would not be able to discuss them accurately with clients as the total costs are not made readily available by fund managers.
Modray: No, I think that TERs should be clearly displayed on product literature. TERs show the full extent that an investor will be hit in the pocket, whereas the more prominently disclosed annual management charges only show part of the picture. There is no doubt that some education is called for. The more universally accepted that TERs become, the more pressure there will be on fund groups to keep a lid on overall costs.
SMV UK opportunities fund manager David Stevenson believes the FTSE 100 is no longer a UK index because globalisation is increasing the correlation of large-cap indices across the world. Do you agree and do you think the FTSE 100 is still a useful index?
Carruthers: Yes, we would completely agree with Stevenson, the FTSE 100 is now very much a global index. But it is still the most quoted and recognisable in the UK media, and thus the most client friendly when discussing the stockmarket investments.
Chadborn: I definitely agree. Some companies quoted in the FTSE 100 have up to 50 per cent of their profits generated in the US so it can not be regarded as a UK index. This same argument could be made against other big indices across the globe but that does not mean they are no longer useful. To the novice investor, it is probably the only index they have heard of and is the only one they can relate to.
Modray: The FTSE 100 is still a useful baronmeter of how the biggest companies are performing but, as a gauge for the entire market, it is very restricted. I agree with Stevenson and do have concerns that some investors buy FTSE 100 trackers without realising just quite how concentrated their investment actually is.
It is important not to forget that the FTSE 100 is a weighted index, the top 20 biggest companies comprise around 70 per cent of the index. In order to achieve reasonable diversity in developed markets investors need to pay close attention to the size of company in which they invest, not just geographics.
The FSA has recently dropped smoothed investment funds from its basic advice regime saying they are too hard to explain. Do you think smoothed funds are too complex to be part of the stakeholder regime?
Carruthers: Yes, we completely agree with the FSA’s reasoning behind its move. When one considers the costs associated with explaining and running these funds they are definitely too high to fit into a 1 per cent stakeholder world.
Chadborn: This crystallises the ambiguity of stakeholder. A competent and experienced adviser should have no difficulty in explaining the nature of smoothed investments in a manner that could be understood by the vast majority of the public. There are many other products and concepts just as complex, such as asset allocation and diversification to spread risk. If smoothed investments are considered too complex, then stakeholder is living up to expectations that it will lead to a dumbing down of the advice process.
Modray: Given that advice under a stakeholder regime is likely to be rudimentary at best, yes. I have concerns over any stockmarket-linked investments being sold under the proposed stakeholder regime because many investors will not fully understand what they are buying and then seek “mis-selling” compensation if the investment falls in value. Perhaps stockmarket exposure should be limited to plans with full capital protection with no income option, but this will be somewhat restrictive.
Hargreaves Lansdown head of investment research Mark Dampier says the traditionally high charges of hedge funds are offputting to most IFAs and that fear among IFAs that they will get the blame if hedge funds do not deliver is stopping the sector from developing. Are IFAs still scared of hedge funds for these reasons?
Carruthers: Until hedge funds are onshore regulated funds with daily prices and daily redemptions then, yes. The new Ucits III regulations does allow providers to launch absolute return based funds, we have seen Baring directional global bond and Credit Suisse target return so far but these have yet to become mainstream investment vehicles for the UK retail market.
Chadborn: I believe most IFAs are reluctant to recommend hedge funds for several reasons but charges are not one of them. For example, IFAs are happy to recommend a higher-charging pension plan over a stakeholder plan because they are confident in the additional benefits to the client so I do not think cost is an issue. The issue is partly due to fear they will get the blame if hedge funds do not deliver but this fear is born out of lack of knowledge and understanding of the product. Only once fully understood can hedge funds be positioned accurately and this would take away the fear of them not delivering.
Modray: I think that some IFAs are scared because they do not understand how hedge funds work and others are equally scared because they do understand how they work and have concerns that, in general, they may have had their day. There is no doubt that the market is becoming saturated, leading to a number of mediocre offerings.
I have concerns that some of the promised “absolute” returns are rather optimistic, especially on products that offer (expensive) capital protection. These protected funds will need to deliver upwards of 16 per cent a yearbefore charges and protection costs to deliver the 11-12 per cent a year net targets mentioned in their brochures, a tall order, especially in the current climate.