Last year's column about fund management return advertising being misleading generated a bit of correspondence. Michael Chamberlain, actuary and principal of MCA NZ, shares the view that any advertising of historic returns will inevitably be misleading because, as we all know, last year's stock market returns rarely repeat.
In fact Tim Bond - formerly of Barclays Capital informed Herald readers five years or so ago that "the stockmarket exhibits serial negative correlation" so any suggestions that historic returns are indicative of the future is a lie. Whilst that is black and white to academics and reasonable people the Commerce Commission and the FMA simply choose not to enforce the law. As last year's column highlighted it is all about interpreting "misleading" but you could argue that the current policy is, um, misleading.
Nevertheless there has been some progress, the finance company debenture debacle got the politicians moving. First off their efforts were focused on financial advisers so we got the Financial Advisers Act, the Code of Professional Conduct etc etc. Whilst hopes are high for "putting your clients' interests first" the reality is likely to disappoint in the short term because the job is only half done in that commission remains as a viable compensation form and some of the regulators may not have a grasp of what doing the right thing looks like or don't see it as their job to set it out clearly like the regulator in the UK does.
It will take a few more disasters to move things along but we are certainly heading in the right direction. Incidentally it isn't surprising that the job is half done because the politicians who make the laws are lobbied continuously by the finance sector so the financial police are always wondering if they will have the support of the politicians.
In putting together the Financial Advisers Act/Code behind the scenes it appears the NZ Society of Accountants lobbied to allow accountants to avoid Standard Set C (an exam which required the adviser to show practical skills in portfolio construction) which may have contributed to the Ross fiasco.
Similarly the Institute of Financial Advisers looks to have lobbied to have the CFP "qualification" used as a substitute for Standard Set C and since then a steady stream of IFA members have appeared before the Courts. Thankfully both of these mistakes have been rectified but they do illustrate the dark forces always operating in the shadows.
The spin is that the next stage in the cleaning up of "Dodge City" is focused on the institutions which provide products to investors. The legislation is called the Financial Markets Conduct Act (FMCA) and it will "govern how financial products are promoted and sold and the ongoing responsibilities of those who offer, deal and trade them". Its main objectives are to "promote the confident and informed participation by investors in financial markets and facilitate the development of fair, efficient and transparent markets".
The two key words here are "fair" and "transparent". It will be interesting to see how these are interpreted.
I haven't had a detailed look at the FMCA nevertheless the key document available for retail investors wanting to research what they are buying is the Product Disclosure Statement (PDS). The Ministry of Business, Innovation and Employment (MBIE) as part of the FMCA has reworked the old disclosure statement and put an example of what it thinks a good PDS should look like on its website for comment.
I have had a close look at the new PDS and to be quite honest thought it was pathetic. In fact if we had a local fund manager listed on the stock market it is a fair bet that its price would have moved up sharply when this document was published. Talk about covenant-light.
So let's have a look at the new, improved disclosure statement. You can find it here.
There are lots of issues with the PDS but some of the main ones that I noticed are as follows:
1. The investment target and strategy objectives on page 4 and 5 aren't realistic at all. There is no way that a retail fund with 75 per cent cash and fixed interest and 25 per cent in shares and property will produce a return of CPI + 2 per cent over the long term, after fees and tax. This is ridiculous and the MBIE needs to look at average yields in the bond market and prospective returns in the equity market, not historic returns. The UK regulatory authority, the FSA, would not sanction this sort of silliness.
2. PDS documents in the US require the issuer to provide a graph of performance relative to a suitable benchmark index. The SEC goes into great detail as to what constitutes a relevant benchmark and this sort of information is critical, allowing for example an individual to see whether the fund manager is adding value or not. Also the SEC requires short, medium and long term returns to be included. This provides a balance to the often misleading performance figures included in factsheets. Inexplicably the MBIE PDS contains none of this.
3. The fee examples on page 1 and 2, particularly as regards ongoing fees, are on average about a half of that typically charged in NZ for retail managed funds. The PDS also needs to stress that annual fees occur annually, duh, and initial fees only occur once so annual fees are a lot more important. Worked examples are required with dollar values.
4. Michael Chamberlain has had a close look at the PDS as well and it is his view that the generic risk comments on pages 1 and 2 should not be included as they take up space that could be better used. Amen to that.
5. The "example of how fees apply to an investor" on page 8 is completely wrong because it doesn't include performance fees or trading costs incurred by the fund manager so the estimated total fees for the year are hugely understated. Maybe the MBIE is unaware that the way that performance benchmarks are specified in NZ mean that performance fees are payable in most cases whether the manager gets out of bed or not.
A realistic "example of how fees apply to an investor" should include the performance fees given normal market returns. In terms of the FMCA this doesn't look at all "fair" or "transparent" but goodness knows how the regulators will be allowed to interpret these words.
6. Last but not least the new PDS does not require fund managers who delegate some or all of their fund management to another fund manager for another fee to disclose the total fees involved i.e. include the cost of second, third or fourth level fees.
This is a big deal. In two weeks time we will look at a NZ managed fund which doesn't break any laws but only discloses annual fees of around 1.5 per cent when in fact actual annual fees are closer to 4.0 per cent pa. A huge hole in the law here that needs to be sorted. Is the MBIE on top of this?
That's probably enough. For retail investors the new laws mean it isn't Dodge City anymore but most Mums and Dads still risk a "walk on the wild side" because unless something is done about the product disclosure statement much of the key information needed to make a decision is not only not being disclosed it is being misrepresented.
This lack of disclosure in NZ is in sharp contrast with the rules in the US.
Brent Sheather is an Authorised Financial Adviser. A disclosure statement is available upon request.