But funds are not quite what they seem
So everything looks great: a massive range of investment products is accessible to the smaller investor, who is protected from harm by regulation, oversight, administration and technology. The humble saver can find investments that suit their needs, while being confident that they are being looked after in the process.
Except that it’s not great, and the small investor routinely gets a really poor deal.
It is easy to believe that there is a very wide range of fund products for the investor to choose from: after all, there is a massive variety of funds available in the market. This is completely wrong.
Really there is only one product.
Not only is there no real product choice for the investor, but there is also no choice about who takes the risk of loss in the fund
Almost all investment funds offer exactly the same speculative product to the investor: the difference in the value of the investor’s share of the fund assets between investment and redemption, less the profits and costs of the fund. That’s the product, and they are all the same. The fact that the fund is a limited partnership, a unit trust or an OEIC doesn’t matter. The fact that the fund holds bonds, equities or alternatives is irrelevant. The fact the fund invests in the Far East, the USA or Europe makes no difference. The product is still the same.
Not only is there no real product choice for the investor, but there is also no choice about who takes the risk of loss in the fund: the investor does – 100% of it. This is the case even in so-called ‘Outcome funds’, where there are structures to mitigate risk, yet 100% of the risk still remains with the investor.
The fund, whatever it is, is a purely speculative investment: the investor gets whatever the value is when they disinvest, with no commitment from anyone as to what that value might be. While taking none of the risk, the fund manager does what they like doing best – picking asset classes, assets and strategies to invest in. The relative success of those strategies may impact the popularity of the fund, and therefore impact the manager’s revenue, but failure does not carry a primary risk of loss to the manager.
In ‘principal-traded’ funds, like OEICs and unit trusts, the fund itself commits to provide liquidity to its investors. They can demand redemption of their holdings at any time, within the frequency published in the fund prospectus. This makes it easy for retail investors to get access to their money, and is seen as a key attribute of collective vehicles. The trouble is that the promise is a sham.
We all know that, when demands for redemption become substantial, funds normally cannot satisfy them, or at least can’t satisfy them without selling the fund’s more liquid assets, thereby disadvantaging the remaining holders, and distorting the fund’s asset mix. High-profile scandals, like Woodford, bear witness to the harm that comes to retail investors from broken promises on liquidity.
A need for focus on outcomes
Small investors generally have an objective for their savings, and are interested in the outcome, not just in speculation: they want to have confidence that they will receive a more-or-less known value at the right time for them. This may be to help them to buy a house, to pay for a child’s wedding, to go on holiday, to pay university fees, etc. This is very different from “I want to take 100% of the risk in a speculative investment that may or may not be able to deliver the value that I need, when I need it.”
Of course, investors like positive returns too, and would naturally like to benefit from growth in the value of their investments. But growth is not their only (and often is not their dominant) motivation.
Platforms and financial advisers are there to match investment funds to investors: they try to bridge the gap between what the funds offer, and what the investors actually want. This is a tough ask, as the investors generally want an outcome, while the funds offer pure speculation.
The investor is asked for their risk appetite, and this is matched to a risk level in the funds that they are advised to buy. But they still take all of the risk, and the returns are still wholly speculative.
Any actual match of a fund’s delivery to a typical small investor’s financial objectives is largely a matter of luck. Consumer duty is not really in the picture.
If fund managers are to deliver outcomes to their investors, and commit to them, then they need to step up from just picking assets and running strategies
Currently, there are some categories of fund that do make commitments to their investors, and that undertake contractual obligations to do so: insurance funds commit to pay out on the trigger of a validated loss event. Defined benefit pension funds commit to make absolute or inflation rate-relative streams of payments to their members, triggered by their retirement. Endowment funds and foundations make indicative commitments on payments to the causes that they support, to give them confidence in available funding.
All of these fund types have their own products, operating models, technology platforms and regulations. In effect, they are separate asset classes, quite distinct from investment funds, which are purely speculative.
In the wider investment sphere, there are some products out there which do offer a committed flow – for example, fixed or inflation-relative bonds or deposits from banks and building societies. In these cases, the provider takes the risk, and the investor knows what they are getting: there is a contractual obligation to pay. It should be clear that, wherever an investment product delivers a contractual obligation, then there are two key responsibilities which the product manufacturer needs to fulfil in some proportion:
• Adequate capital-backing; and/or
• Effective asset /liability management.
Fund manufacturers and distributors take neither of these responsibilities in the delivery of their speculative investment funds: they are thinly capitalised, and the outcome for the investor is whatever it is, without any attempt to match assets to liabilities – which in this case means the outcome objectives of the investors.
If fund managers are to deliver outcomes to their investors, and commit to them, then they need to step up from just picking assets and running strategies.
