The Financial Services Authority is proposing to allow retail consumers access to retail funds of hedge funds, but appears to suggest they should only be distributed with financial advice.
UK investors can now invest in hedge funds, for example, through structured products but there has, until now, been no direct access to funds made up of hedge fund investments so the FSA is introducing an alternative investments regime which introduces consumer safeguards.
More specifically, details of CP 07/6: Funds of Alternative Investment Funds suggest the FSA is looking for feedback on whether FAIFs should only be sold to investors who know what they are doing or when accompanied by financial advice because these products are considered largely unsuitable for the average consumer without advice.
The FSA, at no stage, says products should only be sold when accompanied by financial advice, but presents arguments which hint at the need to ensure consumers fully understand the complexities of products and it might therefore be better directed to sell such funds through financial advisers who do understand how they work.
“As is the case with traditional investment products, it is likely that some FAIF products will be difficult for the average consumer to understand, so providers may consider it appropriate that the product only be sold through the provision of advice,” says the FSA in its consultation.
“Consumers must of course be given the opportunity, through disclosure and, where relevant, through advice, to understand the full nature of financial products offered to them. However, the key to understanding any investment lies in the consumer’s ability to understand how the product might perform in different market conditions.
“We consider that it is likely that some (but by no means all) FAIFs might not be appropriate homes for a large proportion of the consumer’s wealth, but might be suitable for providing diversification when added in proportion to a portfolio of other investments,” continues the FSA.
In an existing case study presented by the FSA in Annex 1 of the consultation, the FSA is proposing because of the complexities of hedge funds – the value of which can, for example rise when equity markets fall and vice versa – consumers may not fully understand the implications of the main investment strategies of varying hedge fund propositions and the use of derivatives.
In deciding how to distribute the fund, says the FSA, “the firm may ask itself whether the relatively complexity of the Fund and the instruments it can invest in might lead it to consider that this product is one where customers would be wise to seek advice, depending on the level of financial capability of the target market”.
As a result, it is suggesting any retail advertising campaign is likely to be delivered in a two-pronged attack: one aimed at investment intermediaries, and the other aimed at existing high-net-worth investors but in a manner which directs consumers to financial advice associated with the product.
“As the campaign is designed to drive custom towards advisers, the two campaigns are staggered to give advisers the time to learn about the Fund via the promotional pack before raising consumer interest. The pack contains….sufficient information to meet the adviser’s needs, the typical type of consumer for whom the product would be appropriate, along with a copy of the scheme documentation,” continues the FSA consultation.
Fay Goddard, deputy director general at the Association of IFAs, says this latest move does appear to be in line with the latest FSA thinking on TCF and the distribution of certain types of complex product, particularly as the FSA is not allowed to insist advice is attached.
"This is in line with the FSA's approach and we support this in relation to high risk and complex products," says Goddard.
"Where the FSA is not in a position to insist people should give advice on these types of product it gives a strong clear message to fund managers they should consider which distribution channel they are using, preferably through professional advice and ideally only through independent financial advice," she adds.
FAIF products could be delivered under the non-Ucits retail schemes regime (NURS), according to FSA proposals, as these are already widely available to investors and allow up to 100% of assets to be held in unregulated collective investment schemes.
Several other rules would be imposed on FAIF managers to protect assets and enforce tighter due diligence on the fund of hedge fund firms.
The FSA says a key element in the FSA's approach is its expectation that the fund manager will operate with ‘due diligence’ but proposed to provide guidance for the fund manager on the maintenance and management of funds.
Responses to the FSA consultation should be submitted by 27 June 2007 so final rules can be disclosed by the end of the year.
If you have any comments you would like to add to this story or would like to speak to its author about a similar subject, telephone Julie Henderson on 020 7034 2679 or email [email protected].IFAonline
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