The Transparency Label Initiative has the potential to significantly improve investors’ returns.

Why?

Timing.  There is a big difference between blindly betting on an opaque security and investing in a security only to subsequently find out it is opaque.

When blindly betting, you only bet on opaque securities where the valuation story suggests you can earn a high enough return to compensate for the near certainty of losing a significant portion of your principal.

When you invest only to later discover you purchased an opaque security, your expected return is not high enough to compensate for the near certainty of losing a significant portion of your principal.

Sub-prime mortgage-backed securities provided an excellent example of the importance of when you know you are blindly betting on an opaque security.

In the run-up to the 2007 financial crisis, asset managers claimed to have sophisticated models that allowed them to see inside and assess the risk/return of the contents of a paper bag (aka, the sub-prime securities).  Based on this claimed “expertise” in valuing these securities, they used their investors’ money to buy securities that were substantially over-priced relative to the actual risk hidden in these securities.

On August 9, 2007, these asset managers discovered the securities were opaque.  But by that time, the investors were already locked into receiving a return that was inadequate to compensate for the true risk of the securities and the expected loss of their investment principal.

Now compare that result to what would have happened if the investors knew upfront the securities were opaque.

Before they blindly bet their money, investors would have insisted on a much, much higher return to compensate for the risk of losing a substantial portion of their principal.  A rate of return higher than the different sub-prime securities offered.  As a result, investors wouldn’t have blindly bet on these securities and would have avoided the losses they generated.

How can investors know if they are investing or blindly betting?

By looking to see if the investment has a label from the Transparency Label Initiative indicating investors can know what they own.  The label identifies transparent securities.  The lack of a label identifies opaque securities.