Be wary of the Adland kitbag

The news that the Financial Services Authority (FSA) is creating a working party to mull how past performance figures are used in the advertising of financial products is a sensible and positive development.

The news that the Financial Services Authority (FSA) is creating a working party to mull how past performance figures are used in the advertising of financial products is a sensible and positive development.

Everyone knows that performance figures are capable of all sorts of manipulation, by the judicious choice of start and end dates, and any number of other little tricks. There is a good case for seeing whether something can be done to introduce a measure of standardisation into the way that figures are used and presented.

Having got itself into a bit of a tangle by opting not to include past performance data in its planned comparative league tables - a decision that elevates theoretical purity above plain common sense - the FSA needs to come up with a more sensible decision this time. What it has to do is to find a way of preventing the most blatant manipulation of figures, without impairing either the general principle of caveat emptor or the right of providers to advertise their brands and products freely in a competitive marketplace.

The reason for taking any action at all rests on the strong prima facie evidence that there is a market failure at work in the way that investors buy managed funds. Misleading advertising may not be one of the root causes of this state of affairs. The culprits are ignorant consumers and misguided (or wrongly incentivised) financial advisers. But advertising, as it is currently presented, undoubtedly capitalises on and reinforces the perception (a) that past performance is a predictor of future success and (b) that returns are somehow independent of risk.

I continue to marvel at the sheer ingenuity with which advertising copywriters manage to wriggle and elide their way through the business of making even the dullest products sound more enticing than they really are. The main tools in Adland's kitbag of cosmetics are (1) selective use of data; (2) comparing apples with pears; and (3) hinting at things which are never quite as marvellous as they appear when you delve into the small print and introduce more meaningful comparative information.

Consider the flyer for Prudential's Prudence Bond, a with-profits investment bond, which quite literally fell out of the pile of newspapers in my kitchen a few days ago. Investment bonds, of which the Prudence Bond is one of the best-known examples, tend to be popular with independent financial advisers (IFAs). According to the advertisement, 350,000 people have some money invested in this particular one. Investment bonds are typically bought by people who are willing to tie up a lump sum in a medium risk fund for a number of years. IFAs like them because they are generally dull but reliable, and you can withdraw 5 per cent of the capital each year and defer income tax on that amount, a tax-planning tool which is beneficial to higher rate taxpayers in particular.

The first slab of copy in the advertisement reads as follows: "£25,000 invested since launch now worth £60,952. That's an average return of over 10 per cent a year. No wonder Prudence Bond is Britain's most popular With Profits Bond."

This seems to be a total non sequitur. It relates an absolute measure (10 per cent per annum) to a relative statistic (the "most popular" bond, whatever that means). The Prudence Bond was originally launched in 1991. According to the latest issue of Money Facts, the average annual return on the Prudence Bond over the last five years (9.68 per cent, including terminal bonus) is actually lower than several similar bonds from well-known providers.

The advertisement goes on: "As exciting as the stock market. As boring as the building society. Want the best of both worlds? Why not invest in Prudence Bond; the lower-risk investment that beats the building society's best rates."

It sounds like an investor's dream. Potential for high growth without the worry of the stock market's ups and downs. This is a clever elision of two different comparisons: between the bond and a building society account, on the one hand, and the bond and the stock market on the other. The facts are that, using five year data again, the Prudence Bond's return of 9.68 per cent compares with the FTSE All-Share's 15.03 per cent over the same period, and the building society account's 2.52 per cent (source: Micropal). With-profits investment bonds are ultimately backed by a fund that invests in a range of equities, bonds, property and cash, and have the added element of a terminal bonus payable from the insurer's with-profits fund. They are deliberately designed to be lower-risk than the stock market.

Without knowing the exact asset allocation of the fund over the period, it is actually difficult to establish whether the bond's performance has been good or bad, though as a general proposition it is an undeniable fact that the average return from life funds is considerably lower than that of counterpart unit trusts or OIECs which invest in the same sectors. Their costs are usually higher. It is stretching language somewhat to imply that the bond is "as exciting as the stock market", when it is clearly not.

The next paragraph reads: "It's the size and stability of the Prudential With Profits Fund - over £72bn - which gives you a big advantage. We have the resources to seek out the best returns. But we also have the financial strength to help protect you against the effects of a fall in the stock market. For consistent, excellent, lower-risk returns, compare Prudence Bond against higher-rate savings accounts." Note here again the way that the comparisons with stock market and savings account are conflated to convey an impression that is not strictly accurate. (The bond provides consistent lower-risk returns when measured against the stock market, and excellent returns compared with the savings account, but not both).

The advertisement also makes much of the Prudential's AAA credit rating (which "lets you know your money really is in the best hands") and the ability to take 5 per cent of your investment each year as "income" (a subtle use of parentheses to describe capital repayment as income). The tax deferral option, it says, is "one of the few ways to boost your annual income without increasing your current tax bill" (the word "current" is the key one, but will investors appreciate the signficance?).

Only in the very small print at the back of the flyer can investors find the information that there are penalties for early withdrawals (score one for the building society account); that "a market value reduction" is possible if market returns fall in future; that the bond's with-profits fund "is not like a building society account" (now they tell us); and that of course "past performance is not necessarily a guide to the future".

So is the advertisement - and there are many much worse - misleading to the average reader? You judge for yourself.

davisbiz@aol.com