Simplifying Investment Product Jargon

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.

Speaking of words, logophiles have cause to celebrate. March 4, 2016 is National Grammar Day.

Alternatives and Retail Retirement Account Owners

The prospect of being part of millions of retail retirement plans has some financial advisors and hedge fund managers giddy with excitement. The 401(k) market alone is huge. According to the Investment Company Institute, as of Q3-2012, these defined contribution plans held an estimated $3.5 trillion in assets. In 2011, over fifty million U.S. workers were "active 401(k) participants." This compares favorably to an approximate $2.66 trillion hedge fund market size in 2013, up from $2.3 trillion one year earlier. Private equity, real estate and infrastructure comprise the rest of the alternatives investment sector according to a press release issued by Preqin, a financial research company. See "Alternative Assets Industry Hits $6tn in AUM for First Time" (January 21, 2014).

CNBC contributor Shelly K. Schwartz explains that alternative investment strategies are appearing in the form of 400 plus mutual funds and exchange-traded funds ("ETFs") that employ "complex trading strategies" such as managed futures, long/short trading in stocks and multiple currency exposures. Allocating to leveraged loans, start-up ventures and global real estate are other ways that these relatively new funds seem to be mimicking the approach taken by hedge funds and private equity funds that traditionally have catered to institutional investors and high net worth individuals. Notwithstanding regulatory differences relating to diversification, percentage of "illiquid" investments, redemption, daily pricing and how much debt can be used to lever a portfolio, statistics suggest a growing interest on the part of smaller investors to get in on the action. See "Seeking safe havens? Analysts, advisors point to liquid alternative funds" (November 24, 2013). Also check out "Goldman pushes hedge funds for your 401(k)" (Fortune, May 22, 2013) in which reporter Stephen Gandel describes new funds being offered by various financial institutions, some of which invest in mutual funds that mimic hedge fund investing strategies and others that invest in hedge funds directly.

Not everyone is an ardent fan. In "FINRA warns investors on alternative mutual funds," Reuters reporter Trevor Hunnicutt (June 11, 2013) describes regulators' concerns that "not all advisers and investors understand the risks involved," especially with respect to whether a retail-oriented fund is truly liquid. In its "Alternative Funds Are Not Your Typical Mutual Fund" publication, the Financial Industry Regulatory Authority ("FINRA") cautions investors to assess investment structure, strategy risk, investment objectives, operating expenses, the background of a particular fund manager and performance history.

Given the ongoing search for the next big thing, we are likely to see a lot more activity in the alternative investments marketplace - for both institutional and high net worth clients as well as for individuals with modest wealth levels. PensionRiskMatters.com will return to this topic in future posts. There is much to write about with respect to fiduciary implications, risk management and valuation.

In the meantime, I want to thank ERISA attorney David C. Olstein with Skadden, Arps, Slate, Meagher & Flom LLP & Affiliates for apprising me of a 2012 U.S. Department of Labor grant of individual exemption for Renaissance Technologies, LLC ("Renaissance").  Described as a "private hedge fund investment company based in New York with over $15 billion under management" by HedgeCo.net (September 26, 2013), Renaissance holds a large number of equity positions in stocks issued by household name companies. Click to see a recent list of their transactions. The "Grant of Individual Exemption Involving Renaissance Technologies, LLC," published in the Federal Register on April 20, 2012 makes for interesting reading for several reasons. First, it describes policies relating to important topics such as valuation, redemption and disclosures for "privately offered collective investment vehicles managed by Renaissance, comprised almost exclusively of proprietary funds" and the impact on retirement accounts in the name of Renaissance employees, some of its owners and spouses of both employees and owners. Second, as far as I know, there are not a lot of publicly available documents about proprietary investment products that find their way into the retirement portfolios of asset management firm employees and shareholders. Third, as earlier described, there is evidence of a growing interest on the part of the financial community in bringing hedge funds or hedge fund "look alike" products to the retirement "masses."