One of the interesting findings of the recently discussed Momentum Investments and Oxford Risk Noise and Investment Advice Study was that the conventional methods of assessing risk of individual investors, is subject to a fair amount of noise. The study pointed out that humans are prone to ‘noisy’ errors, unduly influenced by irrelevant factors, such as their current mood, the time since their last meal, and the weather. But what about noise that should send warning signals to the investor and the decisions they make? According to the UK’s Financial Conduct Authority (FCA), investors often perceive risk warnings as ‘white noise’.
“Many investors perceive risk warnings as “white noise”, and often the genuine possibility of losing money does not sink in,” according to the FCA. As a result, the regulator suggests that investors may be required to demonstrate that they have enough knowledge about financial products, by passing an online test or watching an educational video. These comments were made as part of a discussion paper with proposals to strengthen rules around high-risk investments and help people to avoid losing money from inappropriate schemes. This trend has picked up in South Africa as well, as evidenced by a substantial increase in warnings from the FSCA.
Furthermore, research released by the Financial Services Compensation Scheme (FSCS) found that one in five retirees has considered riskier investment and pensions products in the search for higher rates of interest. “The prolonged low interest rate environment may have made it more tempting for some people to consider riskier investment products.”
The discussion paper of the FCA seeks views on 3 areas where changes could be made to address harm to consumers from investing in inappropriate high-risk investments:
- The classification of high-risk investments: The FCA’s classification of investments determines the level of marketing restrictions that applies to that investment. The FCA is seeking views on whether more types of investments should be subject to marketing restrictions and what marketing restrictions should apply, for example for equity shares and Peer-to-Peer agreements.
- Further segmenting the high-risk investments market: The FCA is concerned that despite its existing marketing restrictions, too many consumers are still investing in inappropriate high-risk investments which do not meet their needs. Therefore, the FCA plans to strengthen its rules to further segment high-risk investments from other investments and is seeking views on how best to achieve this. The FCA is considering what improvements could be made to risk warnings, which are often perceived as white noise to many investors and often do not convey the genuine possibility of an investment loss. Other suggestions in the paper include requiring consumers to watch educational videos or to pass an online test to demonstrate sufficient knowledge about financial products. This could help prevent consumers from simply clicking through and accessing high-risk investments that they do not understand.
- The approval of financial promotions: Firms which approve financial promotions for unauthorised persons play a key role in ensuring those promotions meet regulatorystandards. The FCA is seeking views on whether there should be more requirements for these firms to monitor a financial promotion on an ongoing basis, after approval, to ensure it remains clear, fair and not misleading.
Preventing harm in the consumer investment market is a priority for the FCA. “Recent research it commissioned on self-directed investors identified a growing trend of retail investors choosing to invest in inappropriate high-risk investments that do not meet their savings goals and investment needs,” according to Sheldon Mills, Executive Director, Consumers and Competition at the FCA. “This can lead to significant and unexpected investment losses.” The research also found that over 4 in 10 (45%) did not view ‘losing some money’ as a potential risk of investing.
The South African trend
Local investors looking for a quick buck can be dated back to the days of “vrot melk” and a famous heart surgeon’s Cleopatra elixir to ensure longevity. More recently, imploded property syndications led to untold heartache and despair for desperate investors.
The current low rate of interest, exacerbated by the pandemic and job losses, no doubt makes desperate investors an easy prey for scammers. This applies even more to older people who rely on interest earning investments to fund their daily cost of living.
Seldom, if ever, was there a better time for a regulator to apply a pre-emptive and proactive approach to safeguarding vulnerable citizens. The financial services industry, too, should play a far more important role in this regard.
A major threat, identified by the UK regulator, is of course the number of DIY investors who elect to surf the internet for wonderful opportunities. Not only are they exposed to untested waters, but also miss out on the opportunities for recourse offered by regulated entities. In Australia, where the investment advice industry was decimated after scandals following a Royal Commission, only 12% of people who invested, made use of an adviser in 2019.
It is in our own long-term interest that we guard against this by nurturing the client/adviser relationship.