Being able to make an informed decision about what to buy is important and retirement products are no exception. If language is obtuse, confusing or otherwise difficult to understand, an investor may end up making an inappropriate selection or assuming too much risk.
Although each industry has its share of technical jargon, UK personal finance editor Simon Read thinks there is a "massive problem when it comes to financial services, with the pensions industry arguably the worst of the lot." In "Pension firms urged to use plain English" (Independent, March 2, 2016), he suggests that terms such as "flexi-access drawdown" or "safeguarded benefits" mean little to the everyday reader and are therefore not helpful.
In its 2014 Wall Street Journal compilation of "loathed investment jargon," American Association of Individual Investors ("AAII") executive Charles Rotblut explains "There is too often an assumption that everybody understands what is being discussed, when the reality is much different."
Naming a product for an investment strategy does not necessarily help the investor either, especially if the strategy means different things to different people or has multiple monikers. Products that are part of the smart beta family come to mind.
According to the Financial Times, their use is "swelling," with assets of around $400 billion or one fifth of the $1.7 trillion Exchange Traded Fund market. At the same time, this strategy has no singular definition or name. Ben Johnson with Morningstar describes terms such as "smart beta" and "enhanced indexes" as a "broad and rapidly growing category of benchmarks and the investment products that track them." See "A Sensible Approach to 'Smart Beta'" (Morningstar, May 14, 2014). Eric Balchunas with Bloomberg writes that "Few can define it..."
A 2015 investor alert, issued by the Financial Industry Regulatory Authority ("FINRA"), describes a smart beta index as one that is "based on measures other than weighting by market capitalization" and gives examples of labels being used to market these products. Their recommendation is that interested persons pose six questions before purchasing as follows:
- What is the product's strategy?
- What are the costs?
- What are the potential advantages?
- What are the potential risks?
- How liquid is the product and its holdings?
- Are the performance figures back-tested?
This is not a universal list of questions to ask nor is this type of risk-return inquiry unique to smart beta products. Investors and their advisors should be kicking the proverbial tires on any product being considered. Retirement plan fiduciaries need to do likewise on behalf of plan participants. The message remains the same. In order to make an informed decision, it is important that product language is clear and easy to understand.