A rule recently proposed by the Securities and Exchange Commission could force all funds — not just those that incorporate environmental, social and governance factors — to re-evaluate their names and strategies.
In late May, the commission floated a rule amendment that would allow US-listed funds to include their investment strategies in their names only if at least 80 per cent of their assets aligned with that strategy. Under current practice, the so-called Names Rule includes only “the type of investment, industry, country or geographic region”, as well as their “focuses”. It does not include strategies.
The proposed amendment would cover terms such as “global”, “income”, “intermediate term bond”, “growth” and “value”, as well as ESG-related words, such as “sustainable” and “green.”
Excluding strategies, but not focuses, as the current rule does, creates a loophole around the Names Rule, SEC commissioner Allison Herren Lee said when the rule was proposed.
“The proposal would eliminate this distinction to ensure that investors receive the benefits of the rule whenever a fund’s name suggests that the fund concentrates in investments with particular characteristics,” she added.
If finalised as proposed, funds that specifically identify words linked to their strategies, such as the Pimco Emerging Markets Local Currency and Bond Fund or the Goldman Sachs International Equity Dividend and Premium Fund, as well as thematic ETFs such as the iShares US Medical Devices ETF, would have one year to comply with the Names Rule.
If the proposal is adopted, names would also have to align with plain English definitions and commonly understood industry use and the terms used in a name would also have to be defined within the funds’ prospectuses.
“[T]he proposal quite sensibly seeks to align the branding of funds with the reasonable expectations of investors,” Herren Lee said.
Given the ambiguity of certain terms such as growth and value, the SEC will have difficulty enforcing the proposed rule amendments without resorting to “Monday morning asset managing”, said SEC commissioner Hester Peirce, the proposal’s sole dissenter.
But certain terms, such as “growth”, bring an industry expectation, said Commissioner Caroline Crenshaw. A growth fund typically invests in companies, often emerging ones, she noted, and such investors seek above-average returns through capital appreciation and reinvestment with little expectation of dividends.
To comply with the rule, Fidelity, for example, anticipates having to add name tests or modify existing ones for certain funds, a company spokesperson said.
“We do not anticipate that many, if any, funds will need to make any adjustments to their portfolios, because we already manage the funds consistent with their names and our ESG and sustainable funds have already adopted 80 per cent name test policies,” she added.
Fidelity has 23 sustainable mutual funds and ETFs, including the Fidelity Healthy Future Fund, which debuted in late May, the company said. The firm also has an additional 25 thematic mutual funds and ETFs, its website shows.
The proposed Names Rule amendments could have a particular impact on thematic ETFs, said Ben Johnson, director of global ETF research at Morningstar. Such funds are more likely to have names that mislead investors more than any other sector.
Portfolio managers may have different reasons for selecting each holding in their thematic funds, said Todd Rosenbluth, head of research at VettaFi. Every company held in a “blockchain ETF”, for example, might not be a cryptocurrency company, he noted. The fund could also hold financial institutions that research blockchain technological applications or hold many bitcoin.
Thematic ETFs should therefore carefully consider what might and might not qualify as within their theme to meet the 80 per cent portfolio threshold compliance, Rosenbluth said. “Depending on how the rule is interpreted, it could impact what’s inside many an ETF,” he said.
Fund sponsors will also need to disclose how their funds’ holdings relate to their names, the rule states.
“[T]here will be lots of conversation between the asset managers and the regulators so they can be compliant and yet not make significant changes to the portfolio,” Rosenbluth said.
To comply with the proposed amendment, many funds will be more likely to tweak their names before adjusting the portfolio holdings, Rosenbluth said. Changing a fund’s name to comply with the rule — from “bitcoin” to “cryptocurrency,” for example — could affect flows, but adjusting the holdings could affect performance, he added.
However, fund shops are unlikely to adjust their funds’ ticker symbols, which are not subject to the names rule, he added.
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