The market correction seen in the first quarter in 2020 as a result of the impact of the coronavirus pandemic has highlighted flaws in the controversial future performance predictions under the PRIIPs regulation, with investor returns falling short of funds' forecasts, according to research from Schroders.
PRIIPs, which was introduced in 2018, forces retail investment product providers to publish future performance predictions reflecting a range of scenarios under different market conditions.
The research by Schroders, seen by the Financial Times, shows that investors received lower returns than predicted in their funds' long-term performance forecasts as a result of the March market sell-off.
Investors in ten funds analysed by the asset manager who sold their holdings in a European small-cap equity vehicle in May 2020 after owning it for five years would have received a return of €12,723 on an initial investment of €10,000, falling well short of the €17,870 that an investor would have been led to expect in a moderate market scenario.
It is also nearly €5,000 less than an investor would have received had they sold prior to the corrections, despite projections not having changed substantially during that time.
Under an "unfavourable" market scenario, the performance forecast stood at €10,810.
Short-term investment products were particularly vulnerable to falling short of their performance forecasts, with WisdomTree notably having to close three leveraged oil exchange traded products this year after increased volatility destabilised crude prices. Losses over a single day were not expected to exceed 8% in unfavourable market conditions, according its performance projections.
In July last year, the Financial Conduct Authority accepted widespread discontent over the ramifications of PRIIPs highlighted by its 2018 call for evidence, noting "concerns about potentially conflicting requirements or lack of clarity about how PRIIPs requirements are actually applied."
As a result, the regulator is now considering publishing its own "domestic interpretive guidance" on the rules in order to "mitigate" its concerns about "misleading" performance scenarios methodology, summary risk indicators, and the overall scope of the PRIIPs legislation.
However, the FCA noted it will continue to work in conjunction with pan-European regulator ESMA and the European Commission, "subject to the nature of the UK's relationship with the EU", as part of a European-level review of PRIIPs this year, which will focus "on improving how risk and reward are displayed in the Key Information Document."
The commission has defended the rules since, but is working with EU regulators on potential technical tweaks to the rules.
It said: "It is important to keep PRIIPs up to date based on market feedback and developments, to ensure the rules work for both industry and consumers, while continuing to fulfil the spirit of the legislation."
However, the UK government said last week that PRIIPs rules would be reviewed after Brexit, with Chancellor Rishi Sunak confirmed that the Treasury wants to "improve the functioning" of the regime and "address potential risks of consumer harm".
Sheila Nicoll, head of public policy at Schroders, said the PRIIPs performance projections had "failed the Covid-19 test," adding that this was "not surprising" given the procyclical nature of the methodology.