A look back from the future

History of Finance – primer for 10 year-olds – Spring term, 2043.

Sponsored by the FCA – “Celebrating 30 years of attrition”

Good morning children.

Once upon a time, stock markets always went up, advisers sold products and there was no regulator. Seasoned investors inhabiting this wild frontier understood a simple rule – real asset investments were risky. If you wanted to outpace double-digit interest rates (and inflation) you had to take risks.

Your adviser would probably recommend a “Managed” fund. These unsophisticated funds held a mixture of Equities, Property and Fixed Interest and the manager pretended to move money between these assets as market conditions changed, i.e. from going up a bit, to going up a lot.

At the turn of the millennium, markets entered adolescence, stopped doing as they were told, and began behaving very badly. Since the rules now allowed investors to lose money, investment products were less attractive. Consequently the industry felt investors should be offered investments that wouldn’t grow so much, on the premise that anything that couldn’t grow much wouldn’t fall much either. Asset allocation, a process whereby any manager who had previously bet the farm now bet on the field, became a profitable thing to know about. Investors were offered new “Multi-Asset” funds, vastly superior to the old-fashioned Managed funds in that their propositions contained a hyphen and no suggestion of management.

Product development departments’ customer research discovered that, rather fortunately, investors wanted more products. Rather than the three basic levels of risk, investors wanted as many as 10. It was therefore important to make sure the right portfolio went to the right customer. The first questionnaires had been developed in the 1970s. They consisted of questions like “Would you be interested in an investment that would save tax, was designed to beat inflation and was totally guaranteed against loss?” These were very successful at encouraging new investors.

By 2001, somewhat naïve “Attitude to Risk” questionnaires (ATRs) asked investors a series of questions, and each multiple-choice answer was scored. The scores were added and calibrated with a volatility scale – yes bizarrely in those days people thought upside volatility was a bad thing – to arrive at a portfolio “solution”. The use of the word solution here shouldn’t imply investors had problems – typically during this period the ‘solutions’ caused the problems. Under the 50year rule, we now know that the science underpinning these questionnaires was in fact the result of plagiarism, following a successful legal case brought by a once-popular newspaper called “The Sun”.

In this fashion, investors acquired a Risk qualification. People who shouldn’t have been investing at all were deemed Risk level 1, and people responsible for the financial crisis of 2007-8 being labelled 10. Everybody else was a 4, 5 or 6. The remaining numbers were put in to fill the gaps. By 2012 some managers took to paying independent risk consultants as much as £50,000 to buy an apparently permanent Risk Proficiency Badge that they proudly pinned to their portfolios, e.g. ‘5’. This helped advisers to identify whether the fund would always be suitable for their ‘5’ investors. Of course, adviser businesses had more than 5 investors, until 2013 when RDR made most clients unprofitable.

OK, there’s the bell. Tomorrow we’ll talk about the record launch in 2014 of Psychic Sally’s nil AMC, front-end loaded “Guaranteed Up” fund, and the great Bear market of 2015.

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4 thoughts on “A look back from the future

  • As a ten-year old, I lost you after ‘Once upon a time’

    Reply
  • Looking back from where I find myself today I see a financial world cleverly driven by a compliance regime designed to insulate the industry from its customers.

    Still largely the case for many with Suitability Letters risk Questionnaires and all manner of bum covering activity.

    Happily as we get further into real client relationships this compliance nonsense will disappear into the rear view mirror.

    Your client will be paying you and you will ensure that you instinctively do whatever it takes to retain this relationship.

    May be that you take much less Risk with clients and that you will understand the consequences of your advice rather than “complying ” away your responsibilities and possibly your future income source.

    Times are a changing thank goodness.

    Reply
  • As a ten-year old, I lost you after ‘Once upon a time’

    Reply
  • Looking back from where I find myself today I see a financial world cleverly driven by a compliance regime designed to insulate the industry from its customers.

    Still largely the case for many with Suitability Letters risk Questionnaires and all manner of bum covering activity.

    Happily as we get further into real client relationships this compliance nonsense will disappear into the rear view mirror.

    Your client will be paying you and you will ensure that you instinctively do whatever it takes to retain this relationship.

    May be that you take much less Risk with clients and that you will understand the consequences of your advice rather than “complying ” away your responsibilities and possibly your future income source.

    Times are a changing thank goodness.

    Reply

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