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Projection fate

How can five firms quote different growth rates for the same fund?

If you ask five people the same question, you would not normally expect to get five differ-ent answers. The FSA recently asked product providers a question about projection rates and so far five different answers have already been received, with some results still to be counted.

The FSA’s current projection rules date back to November 1, 2007. The part of the rules that everyone will be aware of reads: “A projection must be calculated using the following rates of return – 5 per cent (lower rate), 7 per cent (intermediate rate) and 9 per cent (higher rate).”

Although drafted at the same time, the rising star in the FSA rulebook is a sentence that adds: “A projection must be calculated using lower rates of return if the rates described in this section overstate the investment potential of the product.”

Since this sentence was first introduced, with-profits projections have been widely affected, especially the funds that have switched investments away from equities and into bonds. Ignoring short-term performance, the rationale is that bonds cannot deliver the same long-term returns that can be expected from equities so the projection rates should be lower.

Following the pension-switching thematic review in December 2008, a “Dear compliance officer” letter was sent to providers in October 2009 to warn against the use of standard rates for cash and fixed-interest funds. In May 2010, the FSA stated that “appropriate action” will be taken where they find non-compliance. It has been estimated that the cost of software changes in the industry could be as high as £5m.

The FSA contends that a strong base for determining appropriate projection rates has been provided but there are no signs of uniformity in the rates being declared so far. When the growth rate for a single fund can vary by up to 1.5 per cent, depending upon who is producing the projection, it feels like the FSA’s strong base is not being interpreted consistently by providers’ actuaries.

Although the idea of a projection is to estimate what might be achieved, some use projections purely as a means of comparing charges and res-ent a copy to their client to be compliant. Everyone can see that illustrating a cash fund at 5 per cent, 7 per cent and 9 per cent is misleading and it could be a real breakthrough for clients to receive lower projections in line with the lower potential returns from more conservative funds.

Authorised firms have a requirement for communications to be “fair, clear and not misleading” but it seems that it will be OK for five firms to quote different growth rates for the same fund and all be right.

Although the ABI lost its battle with the FSA to reconsider its stance on this issue on cost grounds, it is not too late for some kind of collaborative approach from the industry. Perhaps a solution could be found within the established process for allocating funds into the existing ABI invest-ment sectors and specifying rates for each sector.

Graham Miller is director of O&M Systems


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