It should go without saying that choosing the right investment can be challenging. For time-strapped everyday investors, combing through the financial records of individual companies to find a share worth buying can seem like a monumental task.
Instead, many people prefer to put their money into investment funds run by professional asset managers who do have the time and expertise to find the best companies on the market. These funds usually invest in dozens or even hundreds of shares, meaning that the investors benefit from diversification, with their money spread around lots of companies, rather than putting all their eggs into one basket.
However, the problem with this approach is that there are thousands of funds on the market, each themed around different geographic areas, market sectors, asset types, or investment strategies. Choosing the right investment fund still requires a great deal of time and research.
This is where best-buy lists come in. Investment platforms like Fidelity, AJ Bell, and Hargreaves Lansdown compile lists of the best-performing funds in different sectors to help investors choose where to place their money.
“In its recent investigation, the Financial Conduct Authority (FCA) found that investors who used best-buy lists, on average, paid less for their funds and benefitted from better performance, improving people’s outcomes,” says Danny Cox, head of communications at Hargreaves Lansdown.
“There is an eye-watering choice of around 3,000 funds, and without best-buy lists, the risk is that people are paralysed by choice. Our client research has confirmed that people need help choosing funds.”
As a way to inform and educate investors, best-buy lists are a good idea — at least, in theory. In practice, the lists have started to attract more complaints and much greater scrutiny over the last year, both from the market and from regulators.
Common criticisms of best-buy lists include questions of transparency regarding how and why some funds are chosen over others, the appropriateness of certain funds being recommended to retail investors, and the inclusion of underperforming funds.
Some critics even claim that best-buy lists are constructed based on choosing funds that are most profitable for the platform, and not because they perform well for investors.
The issue came to a head last year with the scandal around the Woodford Equity Income Fund. After a long period of poor performance, a spike in redemptions forced the fund to suspend trading last June. Neil Woodford was subsequently fired as the fund’s manager, and in October it was announced that the fund would be liquidated.
Yet despite the fund’s catastrophic underperformance in the months leading up to its suspension, it was still included in Hargreaves Lansdown’s best-buy list — known as the Wealth 50. The platform defended the fund’s inclusion, citing multiple meetings with Woodford that had encouraged them to stick with it.
The Woodford saga led to the FCA announcing that it would re-examine the subject of best-buy lists. Earlier this month, the regulator issued a guidance letter to investment platforms, warning that conflicts of interest can creep into best-buy lists and could lead to customers receiving poor value for money.
“Firms operating best-buy lists must construct them impartially and manage conflicts such as preference for funds offering discounts over formal and objective criteria, lack of independence of research teams and associated governance,” said Debbie Gupta, the FCA’s director of supervision, in the open letter.
“Processes for clear selection, monitoring and deselection of funds on lists should be documented, understood and followed.”
The issue around best-buy lists isn’t just about whether investment platforms misbehaved when picking their favourite funds. If everyday investors don’t feel like they can trust the recommendations of the industry, they might be put off saving altogether. And considering that the UK’s household savings ratio stood at just five per cent in 2019, this would be bad news for the country’s financial health.
“The media and regulatory spotlight was once again on the investment industry in the last 12 months as questions were raised over the suitability of funds on best-buy lists,” says James McManus, chief investment officer of Nutmeg.
“If we’re going to overcome the investing inertia that is so prominent in the UK, more must be done to ensure the appropriateness of products being marketed to retail investors.”
Already, parts of the industry are acting to try and address these concerns. For instance, Hargreaves Lansdown’s Danny Cox says the platform will be making changes in the coming months, including a greater focus on transparency.
“We are redesigning our fund updates, adding more detail, greater transparency and a new structure to our research notes, going further for those clients who want a deeper level of information. And we will be launching new website tools later in the year to address the needs of those who need more help,” he adds.
Certainly, there is a place for best-buy lists as a way to help investors make informed decisions, but there needs to be assurance that these lists are offering quality advice and aren’t simply a marketing exercise. The FCA’s guidance seems like the right approach to addressing these issues. Now it’s on the industry to step up.
Main image credit: Getty