In more than 40 years as an active investor, I have experienced a progressive tightening of the regulatory environment, sometimes long overdue, in the case of RDR, and sometimes completely misconceived. In the case of MiFID2 and PRIIPS, both introduced in January 2018, investors must decide whether these new regulations, the size of seven Bibles combined, are likely to be helpful to their understanding of their portfolio management process and whether in any sense at all their introduction will benefit them.
Investment management is an enterprise with three significant groups of participants, clients, investment managers and stockbrokers, ideally all working together to achieve the investor’s objective. In the case of charities, collaboration with all parties together is particularly significant. Careful consideration of time horizons, combined with income needs, combined with suitable exposure to currencies judged against sterling liabilities, combined with the effect of inflation on costs and income, should all be closely monitored. How do the new regulations assist the process of decision making in these areas?
If we start by considering the implementation of KIDs, we will quickly become confused. These Key Information Documents are now a necessary publication for all collective funds and in the case of investment trusts have a very tight definition of risk. There is a mathematical formula to calculate the degree of risk which can frequently produce the opposite indication of risk to normal considerations. There is one well known Trust which has a highly concentrated portfolio of stocks which are currently fashionable and very highly rated, and even in ‘unfavourable’ market circumstances it is projected to return 10% per annum for years ahead. Trustees may well remember the highly precarious circumstances of 1999/2000 when stocks which had risen in Bitcoin fashion collapsed to 10% or less of their peaks. In those years some charity trustees were persuaded to abandon the distribution of income and move to a total return policy. The message of KIDs is confusing for investors, brokers and fund managers, who may be led astray, by false risk ratings. Some managers of charitable funds are impelled to avoid funds with more cautious asset exposure, and encouraged to invest in more dangerous ones by their interpretation of rules concerning suitable investments.
Turning to research, the implementation of MiFID2 threatens the interests of all three groups of participants in fund management. In my 40 years of professional investment, research has advanced enormously to the benefit of everybody, especially the investors. Advances in technology and the tendency towards frequent trading updates, together with the increase in research production, have progressed towards a more informed understanding of companies for everyone. Investment managers have been able to make their decisions with confidence in their knowledge of the investee companies. The changes in the rules concerning the receipt of research threaten a reversal of this beneficial trend. Fund managers are no longer allowed to receive research unless it has been paid for. The availability of analyst interpretations of company statements is severely restricted and already we are seeing sharp price adjustments in prices on the publication of company announcements. Profits and earnings declared in company announcements are driven by frequent accounting changes and analyst knowledge is required to interpret the underlying patterns of trading. This is now denied to the many and only available to the few who have the resources to pay. Fund managers, investment analysts and investors are all penalised by this rule. Those who believe in efficient markets will have to reconsider.
Now turning to costs and fees, the aim here is admirable but the execution is lamentable. Some notable worthy fund management operations have been sold or closed due to the soaring costs associated with this new regulation. The operations in this area of a leading private bank is just one example. Paying for research is the obvious item but the costs of the KID production, the systems which have to be built to give all the minutiae of transaction costs and the required changes to reports at every stage of the investment management process, threaten a huge extra cost burden on everyone. Brokers and fund managers have seen a major increase in their costs and it is likely that the clients will to some extent pay for this extra overhead.
A particular extra overhead imposed on both brokers and fund managers is transaction reporting. The execution of this new rule is not yet fully developed. Those who use the Stock Exchange’s own new system are required to fill in an extensive spreadsheet for each separate client on every trade they do. The information required is extremely detailed, including the name, date of birth and NI number of each person involved in a transaction, each time that person or client has a transaction completed. The information may not be pre-populated, with consequential scope for human error. It is not yet fully operational but fees are already charged and will continue to be on an annual basis. The clients themselves have to pay an annual fee in order to have a Legal Entity Identifier, which is now a requirement to enable them to buy or sell any quoted security. It would be interesting to know how all this information is to be processed by the recipient.
This regulation threatens to take us back to the imperfections and abuses of the investors’ world when I began, before Big Bang and all the price distortions which followed, culminating in the prosecutions of directors of Guinness and Blue Arrow, and before the Millenium, when parts of the market were so grossly inflated, and before the Financial Crisis years of 2007/08, when the misunderstanding of risk led to the near collapse of the banking system.
Angela Lascelles, Founder and Portfolio Manager OLIM Investment Managers, in a personal capacity
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