UCITS IV, or to give it its full title, the Undertakings for Collective Investment in Transferable Securities Directive IV, comes into force in July. A set of EU directives aimed at allowing collective investment schemes to operate freely throughout the EU, they try to harmonise financial regulation throughout Europe.
The aim of the original Ucits directive was to make open-ended funds investing in transferable securities in all member states to be subject to the same legislation. But for retail customers, it will affect how fund risk is communicated.
The most noticeable to retail fund investors will be the key investor information document (KIID), which will replace the simplified prospectus as the primary document via which fund promoters communicate with prospective clients.
All new Ucits funds launched after July 2011 will have to issue a two-sided KIID, written in a clear, non-technical language and in a common format. All existing Ucits funds must put the same document in place within a year.
Further to this, asset managers are obliged to present their risk and reward disclosure via a synthetic risk and reward indicator (SRRI). This fund volatility indicator will be based on the weekly returns of the fund and on the previous five years. It will then be quoted as a number between one and seven, where one will indicate a low risk/low reward investment and seven will indicate that the investment carries a high level of risk with an equally high level of potential return.
These measures may be championed by some, bu they are not without criticism. Gemma Godfrey, head of research and chair of the investment committee of Credo Capital says “it is easy to see where the appeal of the Ucits measures as a whole lies, with promises of increased liquidity and transparency. However there are three main reservations that I have with the proposals. There are question marks over whether these funds can truly deliver. There are also problems when replicating flagship funds in a Ucits fund, with a widening of the tracking margin, and liquidity disparities, which are made more visible in times of market pressure. Finally, from a fund manager point of view, this extra layer of legislation is going to raise the cost of fund management.”
GETTING BEYOND THE NUMBERS
Petronella West, director of private clients for Quorum Investments, a boutique wealth manager, takes the view that the measures resulting from the directive should not be treated as the best way to communicate risk to clients: “When advising a client, the most important thing to communicate to them is downside risk. You should ask ‘can you afford to risk your money?’ We look at their time horizon for investment and their tolerance to investment risk.”
Though the Ucits directive may have lofty aims, in many instances it may achieve consequences opposite to those intended. As 12th-century priest and part-time financial regulation wag Saint Francis of Assisi almost said, “where Ucits seeks harmony, it instead brings discord.” Ss the measures are yet to kick in, and managers and independent financial advisers are yet to really feel the impact of the legislation, but there are worries about the overlap and crossover between the FSA and Ucits legislation. The concern is that this will add to the regulatory burden on fund managers and in turn will increase costs for the consumer. At the same time, a measure intended to improve transparency will deter communication from the industry. According to Petronella West, “with regulation from both sides, there is a risk that the left hand won’t know what the right hand is doing. The intended outcome of these measures is that the consumer is better informed, but over-regulation will make the industry very protective.”
FSA VERSUS THE EC
The FSA has been prickly towards the directive, taking the view that the UK is a highly diversified market compared to its continental equivalents. For this reason it thinks that the “one size fits all” approach may not be the best one. The UK financial sector is also the largest of those that fall within the directive’s scope. The UK financial industry makes up more than 40 per cent of the European sector, yet has only an 8.2 per cent vote share at the European level.
The FSA have also criticised the approach towards the SRRI grading of risk for consumers. Quantifying risk is a difficult task. Whether using standard deviation ratings or volatility statistics, you are not going to be able to find a method that accurately fits all funds. Furthermore, risk is interactive and subjective, and as such it is impossible to simply come up with a system that will suit all investors. It is important to remember that not all clients are the same, and common sense due diligence from the financial adviser is in most cases a more accurate method of communicating important information to a client than a number on a fact sheet. For this reason, although the directive will mean that, in the future, you will be faced with a much clearer investor information document with a helpful number telling you how risky the fund is deemed to be, you shouldn’t be lulled into a false sense of security. You should familiarise yourself with the underlying risk in the fund and not just read what it says on the label. Caveat emptor.