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Verity’s view

Last week came one of those moments which the financial services industry has been building up to for years – the start of compensation payouts for investors in split-capital investment trusts.

Not an easy story to explain. After three difficult minutes on the radio, I real-ised I should have boiled it down to: “Well, about 50,000 investors were sold these investments on the basis that they were one of the safest ways they could make money on shares but they turned out to be anything but so the investors lost about 700m between them. Now they will get some of their money back but it is less than a quarter of what they lost.”

That is the simple explanation. As advisers will know all too well, there is a big difference between a simple explanation, which gives the client an idea of what they are buying, and a full one, which gives them an idea of how it works and what might go wrong.

A full explanation of split-capital investment trusts would require you to explain the meaning and operation of risk and reward, zero-dividend preference shares, hurdle rates and gearing – all words and concepts liable to alienate even a curious listener. You can explain it but it takes a while and your audience may adopt the atti- tude of a car buyer – I do not need to know how the engine works and what might go wrong with it, just how to drive it.

To take that analogy further, the car salesperson might well feel they have never known a car like the one they are selling to display a faulty design so it is a bit unnecessary to tell their clients about hazards such as metal fatigue. If the customers are the worrying kind, they can read all about it in the small print.

What is wrong with that? Exactly that attitude was also on display in the sale and marketing of split caps. Whoever wrote that an investment in zeroes had “more safety features than a Volvo” probably did not feel they were misleading potential investors. The sort of scenario that would lead to a truly damaging crash (a long bear market, for example) had not been heard of for decades and anyway, the phrase allows for that possibility. Volvos still crash. It is just that their safety features should limit the damage in the event of a crash.

That turned out to be untrue. In many cases, losses were worse than with other kinds of equity investment. Few members of the marketing departments that sold these things (or, indeed, the compliance officers meant to watch over them) had analysed what would happen if the hurdle rate was missed, if the trust was geared up, etc. Was that because they were negligent or because, to them, it seemed truly irrelevant?

There is a limit to which clients want to be informed of the possible risks and if the risks seem to advisers (or marketing departments) to be outside chances, why should they dwell on them?

Sure, the marketing department is abusing the trust of the client if it knows something the client does not but what if the literature is presenting the client faithfully with what the author regards as a true picture of the risks?

Did the industry commit a sin of omission, failing to warn clients about risks it was quite aware of for the sake of sales? Did it mislead the public or was it really more of a fool than a liar, believing its own marketing literature and genuinely believing in a fantasy world of great stockmarket returns without risk? I think it is quite possibly the latter.

In spite of trucking hundreds of documents and thousands of hours’ worth of taped conversations over to Canary Wharf in an effort to prove its regulatory virility, the FSA never showed conclusively that fund managers were colluding to boost each other’s returns.

The zeal of the industry in fighting off the allegations is a token of its sense of hurt. It genuinely believed it had been falsely accused. If something had gone wrong with split-cap trusts, perhaps it had been as much of a surprise to the industry as it had been to the investors.

You could extend the argument to sellers of endowment mortgages or personal pension transfers and opt-outs. Most of them, I would argue, did not believe they were misleading investors. If the road to hell is paved with good intentions, advisers really believed everyone would end up with a nice nest egg and – judging by the recent past – no one would really cop a nasty shortfall. Or that they would end up with a better pension from a personal pension policy than from a final-salary scheme.

There the problem bec-omes apparent. If the indus- try meant well, it was incompetent. Unfortunately, the idea that the industry was well intentioned – true though it might well be – is no comfort whatsoever.

Even if every one of those split-cap investments sold to a cautious investor was an “honest mistake” – a reasonable judgement based on all the available facts – investors still ended up buying something other than what they thought they had been sold.

In intent, the industry may never have meant to abuse its customers but that is no comfort if you have lost your life savings. Incompetence may be more forgivable than rampant exploitation but it is no less damaging.

Andrew Verity is a financial reporter at the BBC

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