Independent body needed to provide guidance to investors for complex products

UNTIL recently, there was no independent avenue for ordinary investors to seek help or guidance on fully understanding investment-linked insurance policies (ILPs) that their insurance agents might recommend.

Typically, many end up consulting their friends or family who may or may not be financially trained. This leads to them signing up for ILPs without knowing the true nature of what they are buying (it’s essentially a product that bundles investment funds with a life insurance component) and the associated risks.

Fortunately, now there is an initiative called Redflags, which is a Web-based digital tool launched a few months ago by six enterprising individuals to help simplify jargon in financial product documents, such as ILP factsheets. 

As the name suggests, the tool aims to raise the red flags inherent in such documents that people should be aware of before buying. The intent is not to provide advice but guidance. Powered by artificial intelligence, Redflags analyses the uploaded document and provides a summary, a list of pros and risks, and a ranking of key points based on importance.

However, while such digital initiatives are a valuable first step towards empowering consumers, efforts to increase financial literacy must go beyond ILPs and include all forms of hard-to-understand investments.

This would include complex bank products such as equity-linked notes and other structured products that are often sold to individuals by relationship managers (RMs), and perhaps even securities such as contracts for differences, daily leveraged certificates and structured warrants.

This is not a trivial problem, given that in time to come, retail investors will be given access to private equity and private debt – two inherently risky asset classes.

It is also not just a problem for the financially naive. I recently spoke to a banker with 40 years in the industry who, despite being a savvy, accredited investor, was sold lousy investments by RMs in a leading private bank.

Among these lemons is an investment in a private equity fund that after eight years has not only lost 75 per cent, but is now making a large cash call that investors were not told was a possibility at the start.

Worse, it turns out that those who refuse to pay will have their investment written down by 30 per cent – yet another condition that was not disclosed earlier.

The investment was made based on the recommendation by a sales-driven RM. Many of such purchases are based on trust, but the point is that if a sophisticated investor can be sold lemons whose risks were not highlighted at the start, what hope is there for the ordinary investor?

There is therefore a need for an impartial body that builds on services such as Redflags to provide investment guidance for the public. The distinction between “advice’’ and “guidance’’ is crucial: “advice’’ implies prescription, as in “you should buy this product’’, while “guidance’’ on the other hand is explanatory, as in “this is what this product offers, here are the risks and this is what you need to know before buying’’.

It’s equally important to appreciate that trust in financial intermediaries has its limits. While regulation requires banks to ensure product suitability, the reality is that commission-driven sales incentives often drive recommendations. When things go wrong, it’s often one person’s word against the other.

Having an impartial body provide guidance or a second opinion would serve as a useful check and balance – its very existence, for example, would likely force the industry to pay more attention to proper explanations and disclosures before any selling is undertaken in the first place.

Such a body could be a non-profit organisation, supported by regulators and consumer groups. In time, it should offer human consultation. Whatever form it takes, it’s certainly worth thinking about, especially as financial products are likely to get more complex – and not simpler – over time.