Suitability rule that doesn't suit

WHAT was special about this week was that some of our biggest, safest companies said or did things the stock market did not like and came badly unstuck. BSkyB announced that it planned to spend more on marketing, Smith & Nephew issued a profits warning, Prudential failed to find a buyer for Egg. All were punished out of all proportion to their offences.

That is what happens in the markets these days. Hedge funds seize on any sign of weakness to sell a stock short and the big long-term investors - the pension funds and insurance companies which used to buy more when a stock was under pressure and therefore mitigated the damage - are now among the first to panic and rush for the exit.

But in another sense these events were not special because we live in an age of big company volatility. Whether it is Shell fiddling its figures, Sainsbury and Marks & Spencer losing their way or management mistakes at Abbey National losing everything, the days when blue-chip companies could be bought and locked away have gone. Even those that avoid disaster, such as Vodafone, GlaxoSmithKline or Unilever, have fluctuations out of all proportion to what is happening to underlying profits.

Unfortunately, these companies are not only individually dangerous to hold, they are collectively boring. The FTSE 100 index has gone sideways this year and is still at the level it was seven years ago. There has been excitement, growth and profitable investment opportunity throughout this period, but not with the big boys. The shares to hold have been among the small and mid-cap sectors and, more recently, the Alternative Investment Market.

Unfortunately, most of these opportunities have passed small investors by because stockbrokers do not in general steer their private clients towards them. Indeed, most have a policy to steer clients away from 'risky' small-cap profits and towards 'safe' big-company losses in the interests, would you believe, of 'investor protection'.

This madness arises out of a Financial Services Authority rule which decrees that advisers must always seek to recommend investments suitable for their clients. Compliance departments then cover their backs by grading stocks according to risk, with the biggest being safe and therefore suitable for Aunt Agatha, and the smallest being toxically risky and suitable only for bitter enemies.

Needless to say, the fund managers who funnel their hapless clients into the likes of Marconi put their own personal money quietly into small companies.

They do this because they know a portfolio of perhaps 20 smaller companies offers a much more attractive investment opportunity than a similar sized portfolio of big companies. All the statistics prove it. And it is probably safer. If the bottom 1,400 companies listed on the Stock Exchange all went completely bust, it would still only amount to onetwentieth of the capital destroyed by Marconi.

The unintended consequences of the suitability rule are so bad for Britain that it ought to be scrapped and advisers left simply with a duty of care to their clients. For not only do investors miss out, the companies miss out too because their shares are illiquid, they can't get the capital they need and their growth is stifled.

Thus the whole country suffers from this nonsense. Only with the help of a regulator and only in Britain could we create failure out of such a golden opportunity.

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