Tim Mortimer, managing director at Future Value Consultants, explains how the requirement for asset managers to display future performance simulations on their fund literature under PRIIPs regulations has created problems.
Fault lines exposed
It is an extremely ambitious concept to assess funds, insurance products and structured products under one common regime (the desire for standardisation) and in such a detailed fashion (the desire for prescription).
It my view, it is that scope and detail which created the fault lines so dramatically exposed last month.
Eight fund groups make last ditch attempt to change PRIIPs rules
The numerical sections of the KID are intended to provide investors with information that tells them about the investment they are considering and provide comparisons with alternatives. The calculations that must be shown are those of risk, costs, and performance scenarios.
While there has been debate over how PRIIPs should assess risk and costs, it is self-evident that a risk calculation should capture all the possible behaviour of the investment's return and that the cost measure is based on a sum of all relevant cost elements. We would expect any robust methodology to produce reasonable results for both.
The central objection of the large and powerful fund management industry was over the basis for the calculation and presentation of performance scenarios. It is the issue of how to show performance scenarios which I believe were not sufficiently thought through, which ultimately led to disastrous consequences.
Investors should be able to understand cost and risk numbers for what they are - respectively the objective measure of what is deducted over the life of an investment and a single encapsulation of how much money could be lost.
Back to the future
To give an idea of how a product might perform, the mutual fund industry has presented investors with past performance figures for many years.
Typically, it shows how a fund has performed over a one, three and five-year timeframe, and may also include a comparison to a recognised benchmark, or other funds in the same sector.
The advantages of such an approach are that performance data is easy to calculate given sufficient track record and the results are easy to verify. The choice of an appropriate benchmark or fund sector is occasionally difficult to determine, but, by-and-large, it has worked well over the years.
There are two major objections with using past performance for the PRIIPs performance scenarios.
The first is that the results are heavily dependent on market conditions in the previous five years. However, if the statistics are presented as past performance figures with suitable disclaimers then they should be easy to interpret. The use of a benchmark or sector average will give context about overall market performance.
Additionally, we should anticipate that diligent investors - or their advisers - would refer to KIDs across different products when making an investment decision. This means that the playing field is relatively level at any point in time because all investments are being compared over the same past horizon.
The second shortcoming of using historical past performance is that for investment types other than funds it is generally more difficult to define and calculate such performance, because structured products and some insurance products are offered in tranches on a regular basis, the terms of which vary according to market conditions.
