The CFA Institute Research and Policy Center has developed a new investment classification framework and issued policy recommendations for regulators and firms designed to improve transparency, communication, and investor comprehension associated with smart beta, direct indexing, and index-based investment products.
The association writes that the newly launched classification framework offers investment firms a tool to better communicate index-based products to clients by describing index-based strategies according to their level of active decision making. It proposes a framework of indexing along a spectrum of strategies beyond traditional market capitalisation weighting.
The framework is based upon three dimensions of strategy, sources of returns, and level of discretion, with the goal of increasing transparency among index-based investment products.
Accompanying policy recommendations emphasise the importance of transparency and clear disclosures around the active investment decisions involved in index-based products.
Rhodri Preece, CFA, Senior Head of Research, CFA Institute says: “The notion of a simple bifurcation between active and passive investment products is outdated. Index-based strategies are varied in their design features and involve different layers of active decision-making, dispelling the historical distinction between active and passive management. As index-based products have proliferated, incorporating more complex features than market capitalization weighting, there is a need for greater transparency and improved investor comprehension of these strategies. This new framework intends to support investment advisers and end-investors through clearer disclosure and communication of the key features of index-based products.”
The research includes recommendations for investment firms grounded in the principles of improved disclosures for clients, including:
Educate and inform investors of the active decisions made throughout the investment process for index-based investments.
Communicate to investors about the decision-making processes involved in index fund creation, including security selection and weighting methodologies used in the creation of the investment product or strategy.
Provide prospective clients with access to more detailed information on index product features as part of the pre-sale product literature.
