I like to read Doug Steiner’s columns in the ROB Magazine. You never know what he’s going to write about. You do know, however, that he will have a strong view on whatever it is.
In this month’s issue, Doug introduces us to the notion of “shrouding”, a word coined by David Laibson of Harvard and Xavier Gabaix of MIT. Shrouding means “hiding key information from consumers.” The academics divide the world into two types of businesses – those that inform their customers up front about everything they need to know about the service or product, and those companies that don’t. Doug gives us a few examples of shrouding, but he doesn’t wade into the murky waters of retail investment products, perhaps because the examples of shrouding are too numerous to mention.
I, along with other independent voices, have ranted and raved about the lack of transparency of most of the structured products being sold today. The banks and other big distributors have clearly taken a shrouding strategy to sell billions of dollars of principal-protected notes and other closed-end funds:
- Investors don’t know what fees they’re paying.
- They don’t know if they even need insurance built into an investment product (i.e. principal protection).
- They don’t know the investment tradeoffs they are making (i.e. limited upside in exchange for no risk of capital loss).
- And they don’t know how (un)likely it is that they will achieve the advertised rates of returns.
On the latter point, a few months back I wrote about a CIBC product (PPNs III: Believe Me. I'm Not Making This Up) that advertised in bold letters that the annual return would be ‘up to 10% per year’. As my simple analysis showed, you’d have better odds of winning big at the lottery than getting a 10% return.
I think the shrouding strategy that the big distributors are using is one of the most shameless activities going on in business today. Everyone knows these products aren’t good for the client, but nobody is willing to stop selling them. PPNs and other structured products are just too profitable. Taking them off the shelf would mean a big hit to the bottom line and make it impossible to meet the budget for wealth management earnings in the year ahead.