This Week's Focus: Standardized information to retail investors. Risk indicators.

This Week's Focus: Standardized information to retail investors. Risk indicators.


Investor protection has improved as the mass marketing of investment products among retail investors has grown significantly. Just two decades ago, the information available to the investor was scarce and too technical, difficult to understand for non-experts in financial aspects of investments.

Bad practices, lack of knowledge and experience, abuses in the placement of investment products and poor information, have involved heavy losses for many retail investors in different chapters of our recent financial history.

In an attempt to improve the information so that investors can make their decisions more knowledge about what is going to hire, they have been put in place, at different times, measures intended to facilitate understanding of the risks associated with investments aimed at the retail public. The prospectuses with information assessed by law, have come to provide comprehensive information on the nature and risks to financial investments. However, its content is not always understandable for most individuals who do not have strong financial knowledge.

To do this, the tendency of the legislator in Spain and supervisors of financial markets, has been, either spontaneous or so by the transposition of rules of European or international level, to reduce the amount of information that is mandatory to facilitate but improve their understanding using indicators that visually allow the investor to understand and compare different investments of as homogeneous and easy as possible.

In Spain, Royal Decree 1082/2012, in development of Law 35/2003 of collective investment schemes and following the content of the EU Regulation 583/2010, introduced the document key investor information, known in the industry for the term DFI (Fundamental Investor Information) or KIID (Key Investor Information Document).

The document key investor information is required both funds and harmonized UCITS, ie that meet the requirements to be marketed in other Member States under Directive 2009/65 / EC, for those who can only be marketed in Spain. The DFI Spanish harmonized funds should not be different from the version in Spanish, but that can only be translated but not altered.

The Circular 2/2013 of the National Securities Market Commission (CNMV) detailing its contents:

  • a) identification of the IIC;
  • b) a brief description of its investment objectives and investment policy;
  • c) a presentation of the historical returns or, where appropriate, profitability scenarios;
  • d) costs and associated expenses, and
  • e) risk / reward investment, with appropriate guidance and warnings in relation to the risks associated with investments in the IIC considered warnings profile.

The DFI has the nature and risks of the investment product that is offered and make investment decisions founded written in non-technical language understandable to the average investor, in order to be reasonably able to understand the essential characteristics, without recourse to other documents. Pre-contractual document is legally considered.

Synthetic indicator of risk-return investment funds and UCIs

Synthetic risk-return indicator is an integer within a scale from 1 to 7 (sorted from lowest to highest risk), based on the level of historical volatility of the IIC. It is stated in Section 2 of Chapter III of Regulation (EU) 583/2010 and in the technical documentation CESR / 10-673del Committee European markets Regulators (CESR), now ESMA (European Market Supervisory Authority).

The calculation of the synthetic risk indicator is the responsibility of the manager or, where appropriate, of the investment company. The methodology for calculating the indicator, based on the volatility of the historical returns of the IIC is as follows:

  • a) the number of weekly returns of the last 5 years is calculated. In case you can not get them, the monthly returns are calculated.
  • b) The volatility of the fund will f annualized data. To calculate volatility, the following formula is used:
    Where returns bottom (rf, t) are measured over the period of time T at intervals of length 1 / m years (m = 52 and T = 260 for weekly data; m = 12 and T = 60 in the for monthly data). R ̅ profitability is the arithmetic mean of the regular fund's returns during the period T.
  • c) The synthetic indicator of profitability and risk corresponds to an integer depending on the volatility calculated based on the following table:

In the document DFI, the synthetic risk indicator should be displayed graphically:

DFI information is easily upgradeable

As can be seen from the above, the synthetic risk indicator does not provide information on the potential losses that may occur to the investor, but only relates the return on investment with regularity in obtaining such returns, since volatility it is nothing other than the standard deviation of the series of returns.

Volatility, therefore, is not a static measure, but it will depend on how the number of returns generated in the past. Given the breadth of the calculation period, 5 years total in periods shorter time, for example in months where especially turbulent circumstances exist in the market or the assets in which it invests, the fund may experience substantially different volatility it has had in the reference period for calculating the indicator.

Volatility is not reliable when estimating potential losses indicator, since it is a measure of statistical dispersion and does not take into account the positive or negative sign of the return of the series on which it is calculated. Therefore, DFI information is not sufficient for an investor losses adversely avoid investing in products that may not be suitable. Perhaps the incorporation of information on potential losses, as the value of the maximum fall (drawdown in English) historical percentage recorded, improve investor information.

In the same vein, and given that the calculation of Value at Risk (VaR) is a very widespread technique in the management to control risk in the portfolios of the funds would be useful for the investor to have that data in the DFI in order to complete the information on the type of investment that will hire. True, the VaR, as a technique for simulating scenarios to assess the maximum loss over a period of time and with a statistical confidence level preset, usually 95% or 99%, is based on historical volatility and the average profitability as parameters to generate the observations. However, improve information by including likely scenarios that may not have occurred during the sample period with which we calculated the synthetic indicator.

Indicator of risk, liquidity and complexity alerts

Elaborating on this line, the Ministry of Economy and Competitiveness in the ECC / 2316/2015 introduced order and classification reporting requirements for certain financial products marketed to retail investors. These obligations do not affect the CIIs, to understand that the information contained in the DFI is enough, but for what I said, I disagree. The Order of the Ministry anticipates European legislation, the EU Regulation 1286/2014, as regards linked investment products and investment products in the form of insurance, which comes into force on 31 December 2016.

The scope of the ministerial order includes, in addition to financial investment instruments set out in Article 2 of the Law on the Securities Market, all products and investment services to financial institutions and insurance companies made available to the retail investor including individual pension plans and guaranteed pension plans. Excluded Public Debt, his reason liquid assets and guarantee the solvency of the state (I will not now discuss this point), investment funds and collective investment schemes, structured deposits and life insurance having an investment component in any investment fund or structured, since they will be subject to European regulations EU Regulation 1286/2014, pending entry into force. Nor are subject pension plans and collective employment insurance that implement pension commitments.

The order, to similarity of the document DFI required of investment funds, establishes the obligation of a standardized information system and classification of investment products to warn about their risk and allow retail investors to choose those that best suit their needs and preferences of savings and investment. Provide information to potential investors or savers includes a risk indicator and, eventually, alerts liquidity and complexity.

The risk indicator is expressed graphically by two possible pictograms, so that it is easily identifiable. This level reflects the following table, depending on the type and characteristics of investment:

As can be seen, in this case the classification criteria is not due to volatility of product profitability, but at the risk of loss or total recovery of the investment to its term or in the long term. Therefore, from the point of view of the retail investor, this indicator provides better information about the risks inherent in investment in terms of potential losses.

This information is supplemented with possible alerts on the liquidity of investment in case you want it back before maturity, as well as the complexity of the mechanisms that generate profitability.

With regard to liquidity, the Order establishes the following as relevant:

  • a) Existence of a commitment to refund part or entire principal amount invested or deposited at maturity.
  • b) That the financial product is not traded on a regulated market, multilateral trading facilities or organized trading systems.
  • c) there is no alternative procedure liquidity to the financial product offered by the originator, issuer or a third party.
  • d) Existence of fees or penalties for early repayment of part or all of the principal amount invested or deposited or rescue life insurance product with savings purpose.
  • e) Existence of minimum periods of notice to request early repayment of the principal or redemption of life insurance product with savings purpose.
  • f) nonreimbursable consolidated until the occurrence of any of the contingencies or, where appropriate, in exceptional circumstances or anticipated liquidity provision, in accordance with the rules of plans and pension law.
  • g) In the case of life insurance saving purpose, linking the right to rescue the market value of the assets allocated.
  • h) In the case of individual plans and associated pension rights assessment mobilization, benefits and exceptional circumstances liquidity market value of the assets of the pension fund.

Alerts in cases a), b) and c) indicate the possibility of significant losses in case you want to recover the investment before maturity, and in the case d) the existence of fees and surcharges. In cases e) and f), the inability to liquidate the investment before the established deadlines or contingencies. And, for the cases g) and h), the possibility of incurring losses on the valuation of assets at market prices at the time to seek reimbursement of the investment. The Order establishes specific texts for each case.

The Order also provides alerts about the complexity of investment products. The complexity has an impact on the understanding of the factors affecting profitability and investment risk, so that some risk factors may not be evident by an investor with little technical expertise in finance. The characteristics of the products considered complex are detailed in Article 217 of the revised text of the Securities Market Law, approved by Royal Legislative Decree 4/2015.

In conclusion, investor protection has improved in regard to clearer, consistent, comparable, understandable and transparent information when we refer to investment products for the retail investor and saver. However, considering that about 50% of national savings is invested in mutual funds, the information contained in the documents of key investor information is improved, especially in the estimate of possible losses in the event that the fund does not evolve similarly to time used to calculate the indicator. In the twenty-first century, should not suffice with the usual warning of "past performance is no guarantee of future results".

See article magazine "Economistas25"