What's in a Name? New SEC Rule Demands Transparency in Fund Names

In a move designed to align fund operations with investor expectations, the Securities and Exchange Commission (SEC) has mandated that investment funds must ensure their names authentically reflect their investment strategies. By a 4-to-1 vote, the SEC has decided that investment funds must allocate at least 80% of their assets in line with the investment focus indicated by their name.

For instance, a "growth" fund must primarily consist of growth stocks, while a "value" fund should mainly hold value stocks.

Gary Gensler, SEC Chair, framed the regulation as a matter of "truth in advertising." While these rules usually see resistance from the commission's Republican members—Hester Peirce and Mark Uyeda—this time, Peirce voted in favor. To put it plainly, she argued that just as you'd expect to find pizza in a "Pizza Shop," investors should find that a fund's holdings align closely with its name.

For advisors, this rule change has significant implications for due diligence. Not only will the fund's prospectuses need to explicitly define terms used in their name, but they must also elaborate on the criteria used to select corresponding investments. This will become a part of the fund's formal investment policy.

Advisors should be on the lookout for these details, as the SEC is hoping to demystify what fund names like "big data" or "artificial intelligence" really mean in terms of holdings.

Advisors will have more concrete information to judge whether a particular fund aligns with their clients' objectives or risk tolerance.

This update is a modification of rules enacted back in 2001, designed to adapt to the evolving landscape of the fund industry. It comes against a backdrop of growing asset sizes and an influx of themed funds, especially those targeting ESG (Environmental, Social, Governance) objectives.

Jaime Lizárraga, a commissioner, emphasized that the rules aim to mitigate "greenwashing," where a fund's stated mission for environmental responsibility doesn't hold water when you scrutinize its portfolio.

Implementation of these regulations will be staggered. The changes take effect 60 days post-publication in the Federal Register. Larger fund groups with assets over $1 billion will have a year to comply; smaller entities will have an 18-month window. The SEC estimates that this rule will be applicable to approximately 10,000 funds, making up about 75% of the market.

Another nuance for advisors to consider is the quarterly requirement for funds to reassess their compliance with the 80% rule, particularly as asset values fluctuate. Funds falling below the threshold will have a 90-day period to correct course. Additionally, derivatives will now be considered as part of the 80% asset alignment.

In summary, this new SEC rule aims for transparency, providing advisors and investors with a more accurate understanding of a fund's strategy directly from its name, thereby facilitating more informed investment choices.


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