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Scottish Mortgage: burn disastrous ‘KID’ documents

22 January 2018

John Kay, senior investment director of UK's largest equity trust, and its co-manager James Anderson, join forces to condemn new 'key information documents'.

The storm of protest from investment trusts at the controversial, new key information documents they are now required to produce has escalated with Scottish Mortgage (SMT), the country’s largest listed equity fund, urging investors to ‘burn’ them rather than read their misleading content.

John Kay, the economist who is the senior independent director at the FTSE 100-listed investment trust, this weekend appealed to investors not to use a document that European regulations for packaged investment products say they must be shown before parting with their money.

‘Please, please, do not Google or download this document, and if you have received a hard copy, burn it before reading. Above all, keep it out of the hands of widows and orphans,’ he wrote in the Financial Times.

Kay, who chaired the 2010 coalition government’s review of UK equity markets, echoed the criticisms of other investment figures for the performance forecasts contained in the KID document but went further in explaining his misgivings.

‘The KID tells you that if you invest in the shares of SMT you might in a “moderate” scenario earn more than 20% a year over the next five years, and over 30% in a “favourable” one. Even in “unfavourable” circumstances, you could anticipate an annual return of over 10%.

‘The KID document does not explain what “moderate”, “favourable” and “unfavourable” mean, but a reasonable person might infer that “moderate” would not be as good for investors as the past few years have been and that “unfavourable” might describe a market downturn — perhaps similar to that experienced in 2000-2 or 2008-9. And the icing on the cake is that these returns can be expected with only moderate risk,’ he wrote.

Kay, said the KID document was the product of good intentions aimed at improving the information available to investors. Unfortunately, he said the decision to base the returns in its scenarios on SMT’s impressive returns over the past five years was flawed as it would raise false expectations.

‘The concept of the Kid is admirable; unfortunately, its execution is a disaster,’ he said.

James Anderson: ‘disturbed’

Baillie Gifford, the Edinburgh-based management group that runs Scottish Mortgage, backed Kay's comments. In a statement, James Anderson, co-manager of the £6.6 billion trust, said he was ‘extremely disturbed’ by the requirements of the Key Information Document.

‘We do not believe that reliance on past performance data is ever a sufficient guide to the many possible future outcomes in stocks and markets. The persistent and steady rises characteristic of the last five years seem especially questionable as a guide.

‘We consider the most important risks in markets to be intrinsically unpredictable and unmeasurable. We would also highlight that the emphasis on the short-run demanded in the KID, seems to us to be acutely misguided,’ said Anderson.

He added: ‘We continue to stress to retail shareholders that we focus, as we believe they do, on building capital in the long-term. We believe that an undue preoccupation with short-term volatility undermines this commitment – and indeed the ultimate purpose of financial markets.’

Wrong notion of risk

Kay, an academic and author, elaborated on this in his article, arguing that the model used by financial regulators and most economists confused certainty and security. ‘The financial economist who knows he is going to be hanged tomorrow has certainty, but not security. He knows that something unpleasant and unwelcome will happen and it is more, not less, unpleasant and unwelcome because it is certain.

‘For the intelligent investor, the unpleasantness or unwelcome outcome that they fear is that their investment strategy fails to meet their reasonable expectations. And that is the relevant concept of investment risk.’

Kay said the KID’s classification of Scottish Mortgage as risk category four out of seven was ‘unhelpful’ as a proper assessment of risk should apply to an overall investment strategy not an individual component of a portfolio such as the investment trust.

‘It would be foolishly risky for anyone to entrust the whole of their savings to an investment in this fund,’ Kay said in reference to SMT, which he described as having a limited range of stocks that reflected its managers’ conviction that rapid technological change would continue and that long-term economic growth would be fast and mostly driven by countries outside North America and western Europe.

‘But,’ he suggested ‘for many people it [SMT] might represent an attractive addition to a diversified portfolio of other investments. In this context, a small holding in a volatile investment may add little to overall portfolio risk especially if the factors that influence the expected return are very different from those that influence the returns on your other assets.

‘In the case of a portfolio that is too risk-averse, it may even reduce risk,’ Kay claimed.

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