Call for FCA to redefine income and capital risk definitions

20 October 2021

Doug Brodie, chief executive of retirement income planning firm Chancery Lane, has called on the Financial Conduct Authority (FCA) to redefine its definitions of income risk and capital risk.

Brodie claims the industry “obsession” with total return is misleading, and believes the fund management industry should move to risk definitions that demonstrate income risk and capital risk separately.

Brodie says: “There is no correlation between equity market risk to capital and stability of dividends. We need to stop just communicating total return payments and show Joe Public what the income will look like.

“Telling an 80-year old who doesn’t work that they have to sit in fixed income and suffer the consequences of low-yielding assets is both illogical and unhelpful when there are other solutions.

“The whole industry can help itself by displaying the different elements or ingredients that make up the cake of a total return. If as a collective we can carry on hiding income reliability behind the capital volatility, it’s partly our own fault and no wonder that the regulator still regards everything being under the one risk banner.”

Chancery Lane has released its annual white paper in which it questions the dynamics in today’s low interest economy, including why models designed for institutional pension funds continue to be used for individual investors and why investment income statistics are hidden by total return figures, thereby layering capital volatility over the top of income stability.

Brodie says: “Typically, risk is defined as volatility, the amount by which an asset moves in relation to its own historical value or to other assets. We believe that is wrong, misinterpreted and misleading. Why does the industry continue to hide annual income stability under capital volatility?”

Brodie says as advisers on regulated investments, Chancery Lane would define risk as the likelihood that an investment will fail to do what an investor expects measured as a percentage.

Brodie explains: “Examining income sources in a zero percentage world leads only to equity and property, yet investment trusts reign supreme for reliability and predictability due to their reserves.

“Our research analysed 31 mainstream investment trusts over the period since 1974, one of the most volatile periods in the equity and bond markets since 1929. In a nutshell, a dividend payment was never missed by any trust – 100% confidence level; the payment was the same or higher than the prior year in 97% of cases and in 89% of cases it increased every year.”

According to Brodie, the simplicity of the natural income approach is more predictable, valuable and reassuring for investors, particularly retirees.

Brodie adds: “The one-time backbone of a retirement plan and our ‘hero’ approach is the humble investment trust, with its ability to support dividend payment and balance sheet reserves which offer stable income to those who have waved farewell to their monthly salary. It may not be sexy, but it is definitely the ‘reliable boyfriend’.”

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