Are the KIDs really all right?

Too much regulation is a familiar complaint from financial services firms, so whingeing about new rules tends to be treated with a pinch of salt. But in the case of the investment company industry’s unhappiness with the European Union’s Packaged Retail and Insurance-based Investment Products (PRIIPs) regulation, that’s unfortunate: this is a reform that stands a good chance of harming the very investors it was designed to protect.

The PRIIPs rules are wide ranging but at their heart sit a new requirement for funds marketed to retail investors to publish key information documents (KIDs); these are standardised information sheets that enable investors, advisers and any other interested parties to compare data on charging, performance and key features of the fund.

What’s not to like about that, you might ask. Well, one problem is that the regulation’s definition of standardised is remarkably sloppy; KIDs aren’t necessarily consistent on how costs are calculated, so investors very often won’t be comparing like-with-like. That’s especially the case with investment companies, where complications such as stamp duty and transaction fees make for particularly difficult reporting problems.

However, the most worrying aspect of the new regulation is its approach to performance data. In particular, the rules require fund providers to make projections about future performance under a range of different scenarios, with the forecasts extrapolated from how their funds have performed over the past five years. The idea is that investors need more guidance about the risk profile of investment funds – for example, are they considering putting their money into a vehicle with the potential for significant volatility or something where potential losses are likely to be modest?

You can see the noble intention here, but this is an accident waiting to happen: this regulation goes against the long-honoured principle that investors shouldn’t be given the impression past performance data is any guide to the future.

Moreover, right now, the bull market of the past five years flatters to deceive, creating a completely false picture of what lies ahead. Any investor who believes the scenarios that providers have been forced to set out in their KIDs, in order to comply with PRIIPs, stands a very good chance of being seriously disappointed in years to come.

No wonder so many investment companies have been reluctant to embrace the regulation, which the analyst Numis this week branded as “misleading”. When it came into force at the beginning of the year, a number of funds did not have compliant KIDs in place, requiring investment platforms to withdraw them from sale. The problem was partly that the final detail of the regulation was only made available late last year, but it certainly doesn’t help that many fund providers believe these rules are deeply flawed.

Who will get the blame if and when investors discover that the hypothetical performance projections they are now receiving actually bear little or no resemblance to reality? You can bet it won’t be the regulators who set PRIIPs up in this way; instead, it will be the investment industry that takes the rap, further undermining fragile trust.

It’s difficult to head off this danger when it comes to retail investors buying without advice. But for clients with intermediaries, these advisers now have an important job to do in managing expectations. They well understand the downsides of KIDs, of course, and it’s crucial to make sure the message is shared right from the start.