December-January 2013

INSIDE VIEW: Refining the Kiid

RefiningThe Key Investor Information Document came into force in July and Duncan J Christie, of State Street, suggests ways to polish them.

The Kiid, or Key Investor Information Document, introduced with Ucits IV, is a central pillar in improving investor protection and facilitating informed decision making as it provides clear information about investment funds. The first Kiids were published in July 2011 and became mandatory for all Ucits funds on July 1, 2012. Since then, the industry has produced hundreds of thousands of Kiids, leading to millions of downloads.

However, there are aspects of the Kiid which may benefit from some improvements. Of these, one important target for investors would be revising the Synthetic Risk and Reward Indicator (SRRI), which provides a guide to a fund’s riskiness. As Ucits funds may eventually come under the over-arching umbrella of Packaged Retail Investment Products (Prips), this task could be undertaken in the next few years, prior to the cross-review of the two regimes around 2018.

The Kiid is capped at two pages, and its mandatory content is designed to inform investors about the nature of investment and general level of risk inherent in a particular investment vehicle. It should also help investors compare different investment products with ease, even though they may at first sight seem quite similar.

The Kiid replaced the longer and more complex Simplified Prospectus required by Ucits III, which – with its technical jargon and often great length – failed to prove useful to investors.

To compare risk and reward effectively across different products, the basis for comparison needs to be meaningful and provide effective contrast. Yet given the SRRI’s current structure, and in the light of on-going market evolution, the SRRI scale as it stands may not be particularly helpful.

The SRRI categorises risk using a numerical scale of one to seven; one indicating low risk/reward and seven indicating high. The data comes from a rolling five-year performance period of annualised weekly returns. Following the financial crisis in 2008, equity funds – the market’s dominant product segment – appear in high concentration at the upper end of the scale, in the six and seven range.

By offering little or no contrast in calculated risk among these funds, the SRRI volatility measure makes it difficult for retail investors to discern distinctions in volatility among these funds, when seeking diversification. As a result, this particular component of the Kiid may actually impede investors’ decision-making.         

To address this issue, it may be useful to consider adjusting the numerical scale. For example, by increasing the upper limit from seven to nine. Additional categories could be combined with a review of the dividing points between categories to make them more granular in areas where there is a high concentration of products. Such a refinement could offer investors a greater level of contrast among funds.

In addition, a nine-point scale would allow for a qualitative three-part overlay distinguishing among “high,” “medium” and “low” risk segments. This could help to give investors a qualitative indication of the risk/reward for a given product on an isolated basis, without the need for a relative comparison to a competing product.

These discussions would hinge on a view of the behaviour of volatility over time, including whether systemically higher volatility is the new “normal” in equities, given the growing interconnectivity of the financial markets.

To help this investigation, State Street conducted proprietary research in November 2012, which looked at equity markets from 1995, including the collapse of the tech bubble in 2000.

In addition to the significant increase in volatility during the 2000 collapse, the data also shows the slow decline in volatility in the ensuing four to five years as the data relating to the immediate aftermath of the crisis was gradually excluded. Contrasting this with the progression of volatility in equity markets in the time since the financial crisis of 2008, we see a continued persistent higher volatility in the four years since, not the decline we saw previously.

Although the SRRI presents one clear opportunity to strengthen the Kiid on behalf of retail investors, other areas could also benefit from refinement. While mooted during the consultation process, their reconsideration would be timely in light of post-implementation lessons learned. In brief, these additional areas for review include:

• Clarification of the guidelines for ongoing charges, to allow for more concrete instructions, enhanced consistency and less room for interpretation of the types of charges covered (for example, securities lending fees) and the methodology used to calculate disclosed expense ratios (for example, treatment of the synthetic portion from fund-of-funds and rebates).
• Further refinements to the SRRI disclosure overall, such as possibly simplifying the calculations behind total return funds, enhancing the narrative disclosure requirements (learning from the Key Fact Statements required in Hong Kong, which do not show any numerical scale, instead they address the risk section with narrative only), and careful consideration of the risk class break points to give more contrast, while not ending up with too frequent changes of class.
• Exemption from the Kiid for institutional investors. They already have a variety of information and risk assessment tools at their disposal. Furthermore, this distinction would more clearly underscore the policy objectives of the Kiid in favour of protecting retail investors.

There is room for a robust discussion among market participants on certain aspects of the Kiid. Packaged retail investment products (Prips) is on the horizon and it may be timely to review the efficacy of the Kiid and the best way forward. Prips has its own Key Information Document, or “Kid”, and the two regimes are scheduled to undergo a cross-review around 2018, four years after the introduction of Prips. We hope that a “best of breeds” result will come from this exercise to the benefit of retail investors.

There will not be one single right answer, and there will always be voices of dissent regarding the number of SRRI divisions and break points chosen. However, the cross-review will be a great opportunity to critically revisit the SRRI design, which will be ten years old by then, and review it based on practical experience as well as actual market evolution.

Duncan J Christie is head of KII Services at State Street

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