Follow up submission to the Treasury Select Committee inquiry into: Restoring confidence in long-term savings

Transcription

1 Follow up submission to the Treasury Select Committee inquiry into: Restoring confidence in long-term savings 19 May 2004 Contact: Stephen Gilbert Parliamentary Affairs Adviser Investment Management Association 65 Kingsway London WC2B 6TD Telephone: Web:

2 2 This document contains additional information requested by the Committee during IMA s oral evidence session on 6 May It is set out under the following headings, as requested by the committee Chairman: Financial education and advertising FSA Reporting Trail Commissions IMA position on Sandler Products Note on US 401(k) Savings Plans In addition there is a note on the equity risk premium that was discussed in the course of the session. 1. Financial Education and Advertising 1.1. The Committee asked us to estimate the respective annual amounts spent by the fund management industry on consumer education and advertising. We contacted several members to discuss their spending, but have found it impossible in the time available to construct meaningful estimates Some members have told us that part of their marketing and advertising budget is applied to product development and research. In addition, marketing and advertising budgets can be split into statutory and discretionary streams. Statutory spend is that which is required by the Financial Services Authority and is one of the features the FSA takes into account in its cost-benefit analysis of regulation. And some of the material required by statute, by its nature, has an educational element. For example, all investors receive a Key Features document (soon to be replaced by the Simplified Prospectus as required by EU law) telling them about their investment, the risks involved, associated charges and the effect of charges and expenses on an investment amongst other things. Companies also have to produce material required to complete a sale such as application forms and Reports and Accounts. Prospectuses are also another source of information for clients There are broadly four types of educational and promotional material produced by IMA members: first, material that is purely educational such as general guides to investing/shares/bonds etc; secondly, material as mentioned above, which is statutory; thirdly, pure marketing material; and fourthly, marketing material which is a mixture of the last two and which includes an educational element For illustrative purposes we have enclosed a limited set of examples of educational material produced by IMA member firms as well as the IMA s educational literature. Details are in Appendix A. As a trade association the IMA has limited ability to ensure widespread distribution of its material. We plan to seek partnership opportunities within which we would further develop our material and methods of distributing it more effectively In addition to printed material many companies run help lines for investors although these are not allowed to run as advice lines. As an example, Fidelity s Investorline and Serviceline take around 120,000 calls per year. Websites are also increasingly important channels for information for those with access to them; there is a huge amount of investment in developing and maintaining web-based material including

3 3 interactive tools to help people understand risk, their own risk profile and what this means when making investment decisions. Finally, some members, like Fidelity, have in the past run seminars and workshops for retail clients As mentioned in the section of our submission dealing with trail commission, direct sales are a very small proportion of total retail sales and a significant proportion of members do not target direct sales at all. There is therefore a need for investment in distributors, such as IFAs, in order to support them in their activities. This in turn has a beneficial educational impact in the marketplace. To this end, companies produce material targeted at IFAs as well as running regular road shows and other events for them, all of which have significant associated costs. Finally, many companies have dedicated staff for educational activities The asset management industry fully supports the need for improved personal finance education at all levels of society. However, the industry alone cannot solve the financial education gap. Any education programme has to be a partnership between government, industry and the education system as well as involving advice and other networks. To that end we are fully supportive of the Financial Service Authority s financial capability agenda. The IMA and many of its members are involved in this work in various ways With respect to the education of potential investors the industry may have a particular role to play in helping to provide information to such a captive audience. As mentioned previously, there is a wide range of industry guides explaining investment, the investment process, risk and the different types of investments available. The IMA also produces general information of this type and it could perhaps be further developed by the IMA in partnership with consumer bodies as a means of enhancing its credibility The industry has also welcomed and been involved in the Personal Finance Education Group (pfeg); the IMA is on the Board and makes an annual financial donation, as do other parts of the industry, including individual companies. Pfeg runs programmes and workshops in over 300 schools across the country. Working alongside 1,000 teachers they have reached over 150,000 pupils. We have identified pfeg projects in or close to constituencies of six members of the Committee, and would be pleased to provide further details if required. 2. Industry reporting to the Financial Services Authority 2.1. In the oral evidence session Mr Ellis mentioned a complaint made to the FSA about split capital investment trusts. This complaint was made while Mr Ellis was working for Hendersons Global Investors, a company he no longer works for; he therefore does not have access to the corresponding paperwork The chain of events was as follows: at the time of the launch of a technology based issue by another firm, Hendersons Global Investors wrote to the FSA about the accompanying advertising which it considered to be misleading. The letter stated Henderson s view that the investment expectations looked unrealistic given the high yield expected from a nil yield asset base. While recognising that the split structure and hybrid mix of assets could provide income, Hendersons Global Investors was of the opinion that the level quoted was very optimistic Mr Ellis believes it is standard practice for compliance and marketing teams to flag up areas of concern with the regulator with respect to what is deemed unreasonable advertising and potentially misleading promotional activities by competitors. This

4 4 vigilance is designed to ensure that the integrity of the industry as a whole is not jeopardised by such practices, or that no single firm gains an unfair advantage. 3. Trail Commission 3.1. Trail commission is the term given to annual payments to intermediaries whose clients continue to hold funds. It was initially introduced to encourage ongoing client support by IFAs Where a product has been bought direct the investor has chosen to buy without advice, and it is the fund management company which incurs the costs of servicing that client s account. It also incurs costs in maintaining non advice-giving telephone help-lines designed to be available to those direct buyers who may need straightforward information about their investments A further reason for maintaining the same charging structure for direct sales as for IFA sales is in order not to undermine network of advice which underpins the vast majority of sales. The benefit to the investor of buying through an IFA is that the IFA has a duty of care to give advice and offer ongoing advice, and in the event of negligence there is the opportunity to seek compensation via the Financial Ombudsman Service and the Financial Services Compensation Scheme. If direct sales were cheaper there would also be a danger that clients would go to IFAs for advice and then to the fund management firm to get a better deal With regard to the transparency of the fee, there is a statutory requirement in the Conduct of Business Sourcebook, which is part of the FSA Handbook, to disclose to a private customer the amount or value, in cash terms, of remuneration or commission. This requirement does not apply if the firm provides the private customer with example key features.provided that the firm discloses to the private customer the actual amount or value of remuneration or commission within five business days of effecting the transaction We were asked to estimate the profits made by the industry from direct sales where the commission that would otherwise have been paid to an advisor is not discounted. We have been unable to do this since we have not been able to estimate the profitability of such business compared with sales through advised and other intermediary channels. It is however notable that direct sales as a proportion of gross retail sales have been steadily declining over the last seven years, as illustrated by the chart in Appendix B. Direct sales have declined from 20.3% of retail sales to less than 9.5% in that period. This strongly suggests that fund management firms do not regard this as a commercially attractive way of distributing their products. We understand from our members that this trend is likely to continue, as direct sales are not a cost effective way of distributing products. 4. The IMA s position on Sandler products The Committee indicated that it would find it helpful to have a statement about the IMA s position in relation to this proposed suite of products The IMA agrees with the analysis in the Sandler Report that a suite of simple and transparent products would be an important ingredient in making long-term 1 IMA responses to the original Sandler proposals and then to the consultation on product specification can be found at and

5 5 investment more attractive to consumers. It believes however that the suite as proposed in the Sandler Report and now being developed by the Government will not be effective in meeting these objectives. IMA suggests that it is more appropriate for Government to develop an over-arching framework, based on the successful model represented by the ISA, within which the industry can design appropriate products to meet the needs of different investors at different stages in their lives. The resulting simple and low-cost administrative structure could then be used for a whole range of products from the Child Trust Fund to simplified pensions Affordability is a key determinant with respect to the suitability of investments offered by IMA members. Every individual should not be viewed as a potential buyer of a product investing in equities and bonds. IMA s Introducing Investment guide takes readers through the process of thinking about whether or not they should invest. Part of this process is designed to ensure they take into account their situation with regard to debt, insurance and available cash. It is only after these issues have been adequately dealt with that it is appropriate to start thinking about investing. The suitability of equity products also has to be examined as the risks associated with equity and bond products may not be sustainable for low-income savers Fundamentally, the question is whether so-called Sandler products will be effective in meeting the needs of investors. The product proposed for the Sandler suite is already available in the market: it is a subset of funds known as the cautious managed sector. This sector currently contains 51 funds, offered by 42 of the 189 IMA member firms, with the majority setting annual management charges in the range of 1-1½ per cent, plus an initial charge of up to 5 per cent; eight funds in the sector have annual management charges of 1 per cent or less. Neither the Sandler Report nor the Treasury have produced evidence to suggest that the Government s proposals will make any difference to demand for these types of products. Without an increase in demand for the products, it will not be economic for the industry to increase investment in their promotion. The experience of CAT standards is that a Government seal of approval alone will not achieve this Sandler products would differ from the existing products in that they could be sold without advice, so that the commission element of the charge would be lower than now, allowing it to be sold within a price cap to be set by the Treasury. If successful, therefore, the result would be more products sold without advice where the investor would today receive it, and a greater likelihood of consumer detriment. In these circumstances it is unlikely that firms will see significant incentive to invest in the development of these products As the FSA s own research shows there was a 20% error rate in outcomes resulting from filtered questions. In their research paper entitled, Consumer testing of a filtered questions approach to selling stakeholder products they found that only 80% of the total sample reached outcomes which were either consistent with that recommended by a qualified adviser (67%) or which were nonetheless reasonable outcomes (13%) The issue of the price cap is a secondary one. The feedback to the IMA from its members is that very few, if any, major fund management firms are likely to launch products under the Sandler brand. To the extent that the price-cap is raised from 1 per cent, that may tempt more to examine the possibility. But the fundamental problem remains: how firms can earn a return on their investment in a new product without any expectation of increased demand from consumers Whether under the existing sales regime, or under that which is to be introduced for Sandler products, there is a very clear distinction between products sold on an execution-only basis and those sold with advice. The FSA rules define execution

6 6 only as a transaction executed by a firm upon the specific instructions of a client where the firm does not give advice on investments relating to the merits of the transaction. While it may be in response to product literature, or a mailing by an intermediary, the employees of a fund management firm will not generally be authorised to give advice, and those who have contact with the public, for example in call centres, are trained not to do so. It is therefore made clear to customers that if they contact a firm direct they are dealing on an execution-only basis The notion that a single class of fund is a suitable entry-level product for all investors is fundamentally flawed. Investment needs vary over an individual s lifetime those of a 60 year old will be markedly different from those of a 30 year old, for example and policy needs to recognise this. The problem with singling out one sector is that, while cautious managed funds may be appropriate for certain investors at certain times, they will not be appropriate for everybody in all circumstances. The risk of putting them forward with a Government-backed badge of suitability is that consumers particularly the less sophisticated may be misled into buying products which are unsuitable for them The alternative proposed in the IMA s earlier written submission to the Committee would enable the industry to recognise these issues by developing products which would have the flexibility to respond to investors evolving needs. The key is to provide a general framework rather than a highly specified set of products. The Government is not well equipped to assess consumer demand and hence the commercial viability of products designed to meet it. Having set the overall policy parameters, including any fiscal incentive, which is the Government s job, it should allow product design to be a matter for the industry - a possible framework is outlined in Appendix C. 5. US 401(k) Savings Plans 5.1. A 401k is a method of saving and/or investing funds on a tax-free basis for employees of American companies. It is a convenient way to save/invest as it is by payroll deduction. Within the 401(k) wrapper the funds accumulate free of federal and state income taxes. The funds withdrawn from the plan are fully taxable as income for federal and state income taxes. Employer matching contributions are permitted, and a vesting schedule exists which could be based on years of service in the plan. Also, the plan may not be top heavy: the percentage of contribution of the higher paid employees may not exceed that of the lower paid employees. Employers offering 401(k) schemes are allowed to offer work-place advice on the schemes At year-end 2002, Section 401(k) plans held an estimated $1.5 trillion in assets, and represented approximately 15 percent of the $10.2 trillion US retirement market, according to the Investment Company Institute (ICI). Assets in 401(k) plans have increased on average 12 percent per year, from $385 billion in Approximately 45 percent of 401(k) plan assets were held in mutual funds at yearend Other institutions, such as insurance companies and banks, held the remaining 401(k) plan assets Participants, on average, have about 62 percent of plan balances invested directly or indirectly in equity securities - the sum of equity funds, company stock, and the equity portion of balanced funds. Specifically, at year-end 2002, 40 percent of plan balances were invested in equity funds (which includes mutual funds and other pooled investments), 16 percent in company stock, and 9 percent in balanced funds. Sixteen percent was invested in guaranteed investment contracts (GICs) and other stable value funds, 11 percent in bond funds, and 6 percent in money market funds.

7 7 Source: Investment Company Institute 6. Equity Risk Premium 6.1. The equity risk premium is the difference between the return on equities and that on the risk free asset averaged over long period. The evidence on the historical risk premium measured from data for 16 countries over the past 102 years in shown in the following table: 6.2. Equity Risk Premia (average % per year based on ) Relative to bills Relative to bonds Geometric mean Arithmetic mean Geometric mean Arithmetic mean UK 4.5% 6.2% 4.2% 5.5% Word 4.6% 5.9% 4.3% 5.4% Source: Dimson & Marsh 6.3. By these standards, 2.5% is low It is arguable that the expected risk premium going forwards may be different from that actually received in the past. For example, the historical risk premium was significantly higher (9.2%) in the second half of the last century than in the first (3.1%) and many commentators have ascribed this to investors being continuously surprised about post war economic performance ie they invested on the basis of a lower expected risk premium than they actually received ex post. Some commentators also argue that the volatility in excess returns will be less in future than they have been in the past so that the arithmetic mean (which is the more appropriate measure) will be closer to the geometric mean in future However, after taking such views into account, the long-term arithmetic mean relative to bills remains about 5% The expected risk premium is the excess return over risk free assets eg bills that an investor requires in order to compensate him for the additional risk of holding equities. Though we might dispute the numbers, were the expected risk premium to be as low as 2.5% and not much more than the cost of investing, then investors would not be put their money into equities. But if that were the case, equity returns would tend to rise and with them future expectations of returns. 2 The two measures are directly related by the volatility. The more volatile the annual data the greater the gap between the arithmetic and geometric means.

8 8 Appendix A IMA educational material Introducing Investment a general guide to investment needs Corporate Bond Funds The Alternative Way to High Income Ethical Investment A Guide to Ethical and Socially Responsible Investment Funds Monthly Savings A Guide to Building up Capital in Investment Funds Saving for Children A Guide to Investing on Behalf of Children through Investment Funds Tax-free savings A Helpful Guide to ISAs The Directory A Comprehensive List of Unit Trust and OEIC Funds of Members of the IMA The Handbook Saving and Investing in Unit Trusts and Investment Funds in Five Simple Steps The Managers - A Comprehensive List of Contact Details for the Retail Members of the IMA Unit Trusts and Tax Completing your Tax Retutn what you need to tell the taxman Selection of members material Aberdeen Asset Management Key Features Document Britannic Asset Management - guide to bond funds, part of a series of guides Fidelity Investments The Fidelity guide to first-time investing JP Morgan Fleming Asset Allocation Your guide to creating the right investment portfolio M & G Investments A Spin-Free Guide to Risk, part of a series of guides Standard Life Mutual funds fund selection guide Threadneedle investments Investing for your future, part of a series of guides

9 9 APPENDIX B Direct Sales as Proportion of Retail Sales 25.0% 20.0% 15.0 % 10.0 % 5.0% 0.0% Jan-94 to Dec-94 Jan-95 to Dec-95 Jan-96 to Dec-96 Jan-97 to Dec-97 Jan-98 to Dec-98 Jan-99 to Dec-99 Jan-00 to Dec-00 Jan-01 to Dec-01 Jan-02 to Dec-02 Jan-03 to Dec-03

10 10 APPENDIX C 1. THE CURRENT POSITION Advice Education Pensions CTF ISAs Funds Funds 2. AN INTEGRATED MODEL FOR FINANCIAL PRODUCTS INVESTORS Consumer education and financial capability Advice greater accessibility Wrappers: integrated pension/isa/ctf Tax incentives rationalised Funds - into Restoring Confidence transparent, in Long unbundled, Term Savings from the Investment Management simplified Association tax May 2004 treatment