Frank Russell Investment
January 8, 2004
U.S. Securities and Exchange Commission
Re: File No. S7-20-03; Exemption from Shareholder Approval for Certain Subadvisory Contracts
Ladies and Gentlemen:
Frank Russell Investment Management Company ("FRIMCo"), a wholly-owned subsidiary of Frank Russell Company ("Russell"), is an investment adviser registered with the Securities and Exchange Commission (the "Commission") under the Investment Advisers Act of 1940. FRIMCo is the principal investment adviser of each of Frank Russell Investment Company ("FRIC") and Russell Investment Funds ("RIF" and together with FRIC, the "Investment Companies"). The Investment Companies are open-end management investment companies registered as such under the Investment Company Act of 1940, as amended (the "1940 Act"). Each of the Investment Companies is a manager of managers fund operating pursuant to a 1995 manager of managers exemptive order1 (the "Russell Order"). The Russell Order superseded previous manager of managers orders issued to FRIC in 1981 and to RIF in 1988.2
FRIMCo is pleased to have this opportunity to comment upon the proposals (the "Proposed Rule") set forth in the above-captioned Release (the "Proposing Release").
Summary of Comments.
In summary, FRIMCo's comments are as follows:
Information Regarding Russell.
Russell is a U.S.-based global investment management firm. Russell was founded in 1936 and has been providing comprehensive asset management consulting services for over 30 years to institutional investors, principally large corporate employee benefit plans. Russell is itself an independently operating subsidiary of The Northwestern Mutual Life Insurance Company, a mutual life insurance corporation founded in 1857 and headquartered in Milwaukee, Wisconsin. Russell's investment consulting practice features a disciplined investment advisory process that guides the investment of more than $1.6 trillion for many of the world's largest institutional investors. Russell has been a pioneer in the employment of a manager of managers structure for its funds.
Since launching its investment management business in 1981, Russell, through its subsidiaries, has created and currently manages over 150 separate manager of managers portfolios and separate accounts distributed to investors located in the United States, Canada, Australia, Japan, Singapore, South Africa as well as in several countries throughout Europe and the Middle East. Within its manager of managers portfolios and separate accounts, Russell creates a complementary blending of many of the world's most talented investment managers. These portfolios and accounts currently have aggregate investment assets of approximately $90 billion.
Russell has developed the manager of managers investment proposition into a sophisticated approach that delivers investment programs for its clients. The manager of managers concept pioneered by Russell over 25 years ago has been imitated by many. Russell believes that its competitive advantage is its continuous and in-depth investment manager research and extensive knowledge of financial markets worldwide. Russell's reputation for independence and objective analysis and advice depends in large part upon its ability to understand and evaluate the capabilities, performance, processes and practices of these investment managers.
Research is central to Russell's investment process. Russell employs more than 75 investment professionals who are engaged in researching investment managers. In addition, Russell employs over 60 portfolio managers and analysts who are responsible for the daily management of Russell's manager of managers portfolios and separate accounts.
Russell's manager of managers investment process involves, but is not based solely on, careful review of performance data against a universe of subadviser investment products based on asset class and investment style through the use of proprietary research and computer models. In addition to these performance analytic tools, Russell also conducts thousands of face-to-face meetings with investment managers each year in order to personally scrutinize each manager's knowledge and investment process. This helps eliminate less skilled managers who show nominal good performance and often identifies new highly-skilled managers before they are well-known. Russell focuses on the people managing the money -- not just the performance those managers have generated in the past or the output from a computerized analysis of their style purity and additional investment return relative to an appropriate benchmark. Among the human factors considered are the skill and background of the investment team, the investment team's cohesion and longevity and the alignment of the investment team's incentives with the investor/client. This face-to-face research, coupled with sophisticated technology for analyzing the components of an investment manager's performance, is the basis for Russell's approach to manager of managers investing.
During 2002, Russell's analysts researched over 2900 investment management firms worldwide, conducting over 2700 evaluation sessions. These evaluation sessions took place on site in 18 countries: Australia, Belgium, Bermuda, Canada, Denmark, France, Germany, Hong Kong, Ireland, Japan, Netherlands, New Zealand, Singapore, South Africa, Sweden, Switzerland, United Kingdom and the United States. Russell's analysts monitored more than 7,500 separate investment "products" offered by those firms and continuously monitored and researched over 3,500 of those products. Of these products, only 474 earned Russell's primary "buy" rating, and only 117 of those products rated "buy" by Russell were incorporated into Russell's manager of managers portfolios and separate accounts.
Information concerning the Investment Companies.
As of December 31, 2003, the Investment Companies comprise shareholder investment assets of over $19.7 billion and approximately 200,000 shareholders of record, not including investors who hold shares through omnibus accounts or variable insurance separate accounts.
Each of the Investment Companies is a series fund with each series operating as a "manager of managers" fund pursuant to the Russell Order. The Investment Companies' manager of managers investment methodology is designed to enable investors to achieve multiple levels of diversification within a single investment portfolio. Each series (a "Fund") of the Investment Companies represents a particular "asset class" (e.g., US equity, fixed income, international equity, etc.). Investors are encouraged to apportion their investment assets among multiple Funds using an asset allocation strategy. Each Fund is diversified by dividing the Fund into strategically allocated portions (each such portion, a "Segment"), each of which is earmarked to be invested pursuant to a particular investment style within the Fund's asset class (such as a market-oriented, growth, or value style for US equity securities). The assets of each Segment are assigned to one or more subadvisers that specialize in the applicable investment style. Each subadviser to the Funds is registered under the Investment Advisers Act of 1940.
FRIMCo develops the investment program for each Fund and recommends to the Funds' Boards of Trustees (each a "Board" and together, the "Boards") the subadvisers for each Fund. The Board of each Investment Company formally approves the engagement of each subadviser. FRIMCo allocates Fund assets among the subadvisers, oversees the subadvisers and evaluates their performance results. The Funds' subadvisers select the individual portfolio securities for the Segment assigned to them. FRIMCo also exercises investment discretion over the portion of each Fund's assets not allocated to the subadvisers and selects the individual portfolio securities for that portion of each Fund's assets and for each Fund's cash reserves. FRIMCo may also directly manage portions of a Fund during periods of transitions from one subadviser to another. For its services, FRIMCo receives an advisory fee from the Funds, a portion of which it transmits to each Subadviser, as agent of the Funds, and the balance of which it retains as compensation.
With the prior approval of the applicable Board, FRIMCo enters into a subadvisory agreement with each selected subadviser. Each subadviser manages the Fund Segment assigned to it pursuant to its subadvisory agreement in accordance with the applicable Fund's objectives, policies, and restrictions and any additional investment guidelines dictated by FRIMCo. Within these requirements and guidelines, each subadviser has complete investment discretion over the management of its Segment and selects the portfolio securities for the Segment it manages. Although each subadviser's activities are subject to general oversight by the Boards and by the Funds' officers, none of the Boards, the officers of the Funds nor FRIMCo approves or evaluates the investment merits of any subadviser's individual security selections. A subadviser has no authority or control with respect to any Segment or Fund other than the Segment or Fund specified in that subadviser's subadvisory agreement.
Currently, FRIC has a total of 52 unaffiliated subadvisers managing the various Segments of its 22 Funds that are not "funds of funds" or money market funds managed by FRIMCo, and RIF has a total of 23 unaffiliated subadvisers managing the various Segments of its five Funds. FRIC also has six Funds that are "funds of funds" that invest in combinations of other FRIC Funds pursuant to allocations determined by FRIMCo and two Funds that are money market funds managed by FRIMCo.
Advantages of Multi-Manager Investing.
The Funds feature well-diversified mutual fund portfolios managed by carefully selecting and combining the investment products of different subadvisers and holding each of the subadvisers to strict investment style guidelines. FRIMCo combines these subadvisers with other subadvisers within the same asset class which FRIMCo believes employ complementary investment styles. By combining investment styles that are intended to be complementary, the Funds are better able to reduce exposure to the risks associated with a particular investment style. FRIMCo continuously monitors and evaluates these subadvisers against their investment guidelines, against the Fund's investment objective, policies and restrictions and against a universe of the subadviser's objectively chosen peers (most of which have not been retained as subadvisers to the Funds). FRIMCo recommends to the Boards the replacement or termination of any subadviser when FRIMCo believes it is in the Fund shareholders' best interests to do so.
Russell, like other investment advisers, believes that investors should seek to hold diversified portfolios that reflect both their own individual investment time horizons and their ability to accept risk. Russell believes many investors can best accomplish this by strategically purchasing shares in one or more of the Funds, each of which has been structured to provide exposure to a specific asset class, and most of which employ a multi-style, multi-manager approach to achieve optimal diversification.
Comments on the Proposed Rule.
I. SUBADVISORY FEES.
A. You have asked whether: (1) the Commission should permit fund directors to enter into subadvisory contracts that increase advisory fees without the consent of shareholders; and (2) the Commission should limit relief to subadvisory contracts that do not increase the portion of the advisory fee retained by the principal adviser in order to assure that subadvisers are selected based on ability and performance.
FRIMCo submits that the Commission should permit directors to enter into subadvisory contracts that increase subadvisory fees without the consent of shareholders, provided that the aggregate advisory fee paid by the fund to the principal adviser does not increase. Shareholder consent should be required if a change to a subadvisory contract results in an increase in the overall advisory fee paid by the fund. The Commission should not limit relief to subadvisory contracts that do not increase the portion of the advisory fee retained by the principal adviser in order to assure that subadvisers are selected based on ability and performance. Therefore, for the reasons set forth below, FRIMCo agrees with the approach taken by the Proposed Rule with respect to this issue.
Pursuant to the terms of the exemptive orders that the Commission has issued granting relief from shareholder voting requirements for manager of managers arrangements (the "Orders"), fund directors have the responsibility to determine, in the exercise of their fiduciary duty to the shareholders of the fund, whether the approval of a new subadvisory contract is in the best interests of shareholders. Any change in subadvisers, or reduction in subadvisory fees that would increase the principal adviser's profits, cannot occur unless first approved by the fund's board of directors, including approval by a majority of its independent directors. At an in-person meeting called for that specific purpose, the directors of the funds review proposals to change subadvisers or to modify the fees paid to subadvisers pursuant to their responsibilities under sections 15(c)4 and 365 of the 1940 Act, as well as under state law. At that meeting, the directors of the funds receive and review information about the reasons for the proposed change, and the fee impact of the change to the principal adviser, as well as any other information that the directors may request. The independent directors' responsibility under certain of the Orders includes the monitoring of the principal adviser's profitability on an ongoing basis, not only when there is a change of subadvisers.
We believe that reliance on independent directors to perform this important function has worked well, and has served to assure that subadviser changes are proposed because such changes serve the best interests of shareholders, and are not made for the purpose of increasing the principal adviser's profitability. In the case of the Funds, the best interests of Fund shareholders are the sole motivating factor for subadviser changes. This is demonstrated by the fact that FRIMCo has frequently proposed subadviser changes that actually increase overall subadvisory costs thus reducing FRIMCo's net revenue. Our experience suggests that there is no need for shareholders to assume the responsibility for reviewing the appropriateness of subadviser fees; this decision is best left in the hands of the independent directors, those who are in the best position to act in the best interests of shareholders.
B. You have also asked whether shareholders need information about the compensation paid to each subadviser.
We do not believe that fund shareholders would benefit from information about the compensation paid to each individual subadviser.
A manager of managers fund is offered to an investor as a single product that charges a single "all-in" investment management fee. That fee encompasses all of the advisory fees charged to the principal adviser by the subadvisers for that fund. The Commission has recognized this relationship and has balanced the competing goals of disclosure of information regarding fees against the benefits of non-disclosure by the principal adviser of fees paid to any single subadviser. The Commission has done so by requiring, as a condition to granting the Orders, that a manager of managers fund disclose in its registration statement the aggregate fees paid to all subadvisers for the fund. This aggregate disclosure permits investors to gauge the principal adviser's expense of obtaining subadvisers, and therefore, the net revenue of the principal adviser. Additionally, each shareholder receives an updated prospectus at least annually and each has the right to request a copy of the fund's statement of additional information (which contains the aggregate subadviser fee information) at any time. Shareholders are able to "vote with their feet" by redeeming their shares at any time if they are dissatisfied with any subadviser change or any change in aggregate fees paid by the principal adviser to subadvisers.
Disclosure of individual subadviser fees would cause unnecessary upward pressure on investment management fees. Most of the investment management firms selected as subadvisers of the Funds are investment managers that focus their business on large institutional accounts - pension funds, corporate accounts, manager of managers investment funds, and other major pools of capital assets. In general, these firms do not offer single-managed products to the investing public, and they generally do not accept asset assignments below a specific threshold amount (often tens of millions of dollars). These firms operate under a published institutional fee schedule that reflects reduced asset-based fees as certain asset levels are reached. However, the fees quoted on subadvisers' fee schedules are often negotiable, particularly if the principal adviser is in a position to place a significant volume of assets with the subadviser.
Russell and other principal advisers to manager of managers funds have the bargaining power both to obtain the services of these subadvisers and to negotiate very favorable fees on behalf of the Funds. Because of the significant assets principal advisers place with investment managers worldwide, the fees charged by subadvisers to the funds are frequently substantially below the posted fee schedules for those managers. Therefore, these fee savings allow Russell and other principal advisers to provide to the investing public very high quality diversified funds at a very competitive overall investment management fee.
Russell believes that many of its subadvisers would not provide the fee concessions to the manager of managers funds that those funds now enjoy if the principal adviser were required to disclose the specific fee arrangements it has negotiated with individual subadvisers. The principal adviser would be forced to increase, perhaps dramatically, the investment management fees it charges to the funds to reflect the increased costs of engaging high-quality subadvisers. Moreover, disclosure of individual subadviser fees may prevent the principal adviser from being able to engage certain high-quality subadvisers who do not wish to have their institutional fee arrangements publicly disclosed. In either case, manager of managers funds and their shareholders would be adversely affected.
From time to time, after engaging a subadviser on behalf of a fund, a principal adviser may be able to negotiate fee reductions with a subadviser. This ability could arise from any number of circumstances, such as market changes, increases in the assets placed with the subadviser by funds by the principal adviser, changes in the fortunes of the subadviser or administrative/ operational changes by the principal adviser that reduce administrative burdens on a subadviser or improve its operating efficiencies. The possibility of obtaining reduced fees would greatly diminish if subadvisory fees were disclosed. Accordingly, principal advisers would likely seek fee increases on existing funds and set fees higher on new funds if fee disclosure were required in order to maintain profitability at reasonable levels, to enable the principal adviser to attract talented investment professionals and to continue to make necessary and appropriate infrastructure investments.
Disclosing subadvisory fees does not materially improve a shareholder's investment decision. In a properly constructed and managed manager of managers fund, the disclosure of individual subadviser fees does not materially aid a shareholder's investment decision. The manager of manager fund is sold on the basis of the principal adviser's overall capabilities in researching, selecting and monitoring a number of subadvisers within the same fund, and where necessary or appropriate, replacing existing subadvisers with others better suited to the task. The individual segments of a fund are not offered to a shareholder as they would be with single subadvised funds, neither can a shareholder "opt out" of a particular segment of a fund if for some reason it disagrees with the selection of a particular subadviser, or the terms on which that subadviser has been retained. Indeed, the purpose of a manager of manager funds is to offer each segment as part of a balanced whole, a balance that can be changed as necessary to meet the needs of the fund and its shareholders. In that context, disclosing individual subadvisory fees is not only meaningless, it is also potentially confusing.
II. OBLIGATION TO SUPERVISE.
We submit that it would be helpful for the Commission to clarify the proposed condition that the contract between the fund and a principal adviser provide that the principal adviser must supervise and oversee the activities of the subadviser under the subadvisory contract on behalf of the fund. As used in the Proposed Rule, the terms "supervise" and "oversee" may not have commonly accepted meanings. Without further definition, confusion may result and contradictory interpretations of such terms may occur. Moreover, the resulting ambiguity regarding what actions, if any, principal advisers are required to take to satisfy this requirement of the rule could easily lead to uneven and discriminatory enforcement. At a minimum, the Commission should clarify in the adopting release that "supervise" and "oversee" do not include items such as the pre-approval of subadviser security selection or the mandating of subadviser operational systems or capabilities.
One possible approach would be for the adopting release to clarify that this condition is not intended to require duplicative subadviser compliance activities by the principal adviser. The adopting release should clarify that this condition does not mean that there exists a single set of activities that a principal adviser must perform as part of its supervisory and oversight functions. As Paul Roye, Director of the Commission's Division of Investment Management, stated with respect to the proposed compliance rule at the Commission's open meeting on December 3, 2003, fund groups are too varied for a one-size-fits-all approach. In the context of the proposed compliance rule, Mr. Roye did not recommend that the Commission specify the types of procedures that each and every fund group should adopt. Similarly, the Commission should make clear that the principal adviser's supervision and oversight of subadvisers should be evaluated from the same perspective.
The hallmark of manager of managers funds is the principal adviser's fiduciary role of active and ongoing monitoring, evaluation and management of each subadviser. In this role, the principal adviser should at all times follow procedures to continuously evaluate the investment style, personnel, performance and other factors relating to the suitability of each subadviser, and compare those factors to an appropriate universe of investment advisers to perform investment management services with respect to all or a portion of a fund's investment portfolio. Principal advisers should take reasonable steps to ensure that subadvisers have, and are following, policies and procedures reasonably designed to perform their obligations under the subadvisory contract and to comply with applicable law, rules and regulations. Principal advisers should:
Principal advisers should not, however, be required to duplicate the functions properly delegated to the subadviser or the obligations, compliance or otherwise, that subadvisers already have. For example, principal advisers do not typically, and should not be required to, evaluate or review the investment merits of individual security selections of subadvisers. After all, subadvisers are selected specifically for their security selection skills. As investment advisers registered with the SEC, each subadviser is subject to all laws, rules and regulations that have been adopted to ensure investor protection. Principal advisers should assess the ongoing appropriateness of the fund's retention of such subadviser. The Commission should take care to avoid requiring any duplication of a subadviser's compliance functions or obligations by the principal adviser. This could impose significant burdens and costs on the principal adviser, substantially increasing the operational cost of a manager of manager approach, possibly even to the extent of making it unfeasible to operate a manager of managers complex thereby depriving shareholders of the significant benefits available under a manager of managers structure.
Finally, the adopting release should clarify that, if a technical amendment to a fund's contract with its principal adviser is required to comply with this condition, that amendment can be approved by the board and no shareholder vote is required.
III. ARM'S LENGTH RELATIONSHIP.
A. Affiliated Subadvisers.
You have asked whether (1) the scope of the Proposed Rule should be expanded to include wholly-owned subadvisers replacing other affiliated subadvisers; (2) the scope of the Proposed Rule should be expanded to include other affiliated subadvisers; and (3) all subadvisory contracts be exempt from the Act's shareholder voting requirement, and, if so, should the Commission expand the Proposed Rule to include all subadvisers?
Based on the premise that no impermissible conflict of interest would be present when replacing one wholly-owned subadviser with another wholly-owned subadviser, the Proposed Rule expands the traditional relief to allow wholly-owned subsidiaries of the principal adviser to replace other wholly-owned subsidiaries of the principal adviser as subadvisers. We recognize that this expansion is based upon an exemptive order issued by the Commission.
However, we do not agree with the Proposed Rule in this respect and do not support the expansion of the Proposed Rule to include wholly-owned subsidiaries replacing other affiliated subadvisers or to include other affiliated subadvisers. A principal adviser should not have the ability to hire any affiliated subadviser without the approval of shareholders. A myriad of potential abuses and conflicts of interest may arise in the context of a principal adviser hiring an affiliated subadviser. Because of the wide variances among corporate structures, we do not believe it is not possible to adopt a rule of general applicability that would ensure that an impermissible conflict of interest does not exist with respect to the use of subadvisers affiliated with the principal adviser. These situations should not be addressed by the Commission as part of the current rulemaking. Principal advisers should seek shareholder approval with respect to affiliated subadviser or should seek exemptive relief from the Commission on a case-by-case basis.
The question as to whether all subadvisory contracts should be exempt from the Act's shareholder voting requirement, and, if so, whether the Commission should expand the Proposed Rule to include all subadvisers could be read to be asking whether all subadvisory relationships should be exempted from the Act's shareholder voting requirements. If this is the question, this expansion would seem to be contrary to the rationale supporting the Orders. We do not believe the Proposed Rule should be expanded in this manner.
B. Material Interest in a Subadviser.
The Proposed Rule prohibits fund directors, fund officers, the principal adviser and officers and directors of the principal adviser from owning any material interest, directly or indirectly, in any subadviser. The Proposing Release does not discuss the meaning of the term "material" in this context. The Orders permit such ownership of a subadviser if it is less than 1% of the outstanding securities of any class of equity or debt of a publicly-traded subadviser or an entity that controls, is controlled by or is under common control with a subadviser. The adopting release should clarify that, in this context, ownership of less than 1% of the outstanding securities of any class of equity or debt of a publicly-traded subadviser or an entity that controls, is controlled by or is under common control with a subadviser is not material.
IV. EXPECTATION OF INVESTORS.
You have asked whether the proposed requirements are adequate to assure that investors understand that they are investing in a manager of managers fund.
Shareholder Authorization. This requirement should be adopted as proposed. However, the Commission should clarify that funds operating under the Orders will not be required to obtain shareholder authorization to continue to operate as manager of managers funds under the rule if the Orders are rescinded. Shareholders of funds currently operating under the Orders have either already approved the manager of managers structure or were aware at the time of purchase, through prospectus disclosure, that they were investing in a manager of managers fund. Requiring shareholder approval for funds operating as manager of managers pursuant to the Orders would impose significant and unnecessary expenses on these funds.
Prospectus Disclosure. This requirement should be adopted as proposed. The prospectus for a manager of managers fund should clearly disclose the principal adviser's ability, subject to approval of the fund's board, to retain and discharge subadvisers without shareholder approval.
Information Statement Requirement. We acknowledge that the Orders have contained a condition requiring the delivery of information statements to shareholders. However, since the Proposing Release provides an opportunity to comment, we would like to suggest that such comprehensive information does not serve the interests of investors. The requirement that funds send an information statement to investors does not, in our view, further the goal of ensuring that investors understand that they are investing in a manager of managers fund, that they receive relevant information about who the subadvisers are and that investors understand the subadvisers can be changed at any time without shareholder approval. We believe shareholders should receive information relating to a new subadvisory relationship or a material change to an existing subadvisory relationship; however, we do not believe that the information statement is the most appropriate means for doing so.
The information statement condition contained in the Orders developed from the notion that, even though shareholders were not given the opportunity to vote on a subadviser change, shareholders should still receive the information they would have received if given the opportunity to vote. An information statement is typically used in connection with a meeting of shareholders to provide shareholders with enough information to allow them to make an informed decision. However, shareholders of manager of managers funds are not being asked to vote on subadvisory changes. Therefore, we do not believe it is necessary for shareholders to receive the same in-depth information that they would receive if they were being asked to vote. Requiring disclosure that is not relevant to the subadviser change may obscure the relevant information. A more focused and succinct notice to shareholders would be most useful to shareholders and most cost effective for manager of managers funds. The goal of ensuring that investors receive sufficient information to understand they are investing in a manager of managers fund can be achieved by a more simple focused notice sent to shareholders. Therefore, we recommend that the Commission consider the following approach.
We propose that the Commission revise the Proposed Rule to require that within 90 days of entering into a new subadvisory contract or after making a material change to a wholly-owned subsidiary's existing subadvisory contracts, the fund furnish its shareholders with a notice that contains the following information:
Clear and meaningful prospectus disclosure is the most effective means to ensure that investors understand they are investing in a manager of managers fund. The prospectus is provided to investors at the time of purchase. The prospectus describes that the fund is a manager of managers fund and that the principal adviser may hire and fire subadvisers without the approval of shareholders. The only subadviser specific information (for funds with more than one subadviser) included in the prospectus is the name and address of each subadviser. The disclosure relating to a subadviser change required by an information statement, however, is far more detailed and extensive than the disclosure relating to existing subadvisers required by Form N-1A. Providing shareholders with an information statement that contains more detailed information than they received at the time of purchase does not further the goal of investor understanding, nor does it meaningfully assist a shareholder in deciding whether to redeem their investment. Moreover, the limited utility of the information statement to shareholders does not justify the expense involved in creating and distributing it.
Simply providing shareholders with a notice containing information proposed above would provide them with more information than they received at the time of their investment decision, would notify shareholders that there has been a change of subadvisers in their fund and would reinforce the fact that they have invested in a manager of managers fund. Therefore, notwithstanding the conditions in the Orders, FRIMCo believes that the Commission should consider whether shareholder understanding is furthered from the receipt of an information statement or whether providing shareholders with a notice containing the information proposed above is more relevant and adequate.
We do not believe that any regulatory purpose would be served by requiring shareholder notices of subadviser changes to be filed with the Commission. Current information regarding subadviser changes is provided in prospectus supplements, which are filed with the Commission, and shareholder notices would be subject to review by the SEC staff during periodic examinations. If the Commission believes, however, that requiring the filing of notices would be beneficial, we recommend that funds be required to file all notices provided to shareholders collectively on an annual basis. In this regard, the Commission could adopt a form specifically for the filing of such notices.
Subadviser Name Included in Fund Name.
You have asked whether the rule should prohibit the use of the subadviser's name in a manager of managers fund to assure that investors are investing in a fund based on the principal adviser's reputation for selecting and supervising subadvisers.
We believe the rule should prohibit the use of the subadviser's name in the name of a manager of managers fund. Shareholders purchase a manager of managers fund managed by the principal adviser with the expectation that subadvisers will, from time to time, be replaced without a shareholder vote. The use of the subadviser's name in the name of the fund could be misleading as the principal adviser will have the ability to terminate that subadviser without shareholder approval. Use of the subadviser's name in the name of a manager of managers fund is inconsistent with the basis on which the Orders were granted in that it implies that the principal adviser may not have the ability to readily terminate the subadviser. Therefore, a subadviser's name should only be allowed to be used in the name of a fund when that subadviser cannot be changed without shareholder approval.
V. NUMBER OF SUBADVISERS.
You have asked whether (1) the circumstances involving single subadvisers are sufficiently similar to those involving multiple subadvisers to justify similar treatment; (2) the Proposed Rule should include as a condition that the principal adviser engage multiple subadvisers for each fund or series; and (3) any of the conditions in the Proposed Rule should be modified in the case of a single subadviser fund.
We believe that the rule should apply equally to manager of managers funds regardless of whether a fund employs a single subadviser or multiple subadvisers. None of the conditions in the rule should be modified in the case of a single subadviser fund. Therefore, for the following reasons, FRIMCo agrees with the Proposed Rule on this matter.
A manager of managers investment company should be permitted to have single subadviser funds. A blanket requirement that a fund relying on manager of managers fund exemptive relief be required to employ a minimum number of subadvisers is potentially harmful to investors. There are instances in which such funds legitimately employ only a single subadviser while retaining the need for the services of a principal adviser, such as FRIMCo, to select, actively monitor and manage that subadviser and to evaluate other potential subadvisers.6
Those circumstances may include the operation of tax-managed funds, where tax-managed strategies may often be carried out most effectively by a single subadviser that tracks tax-lots of portfolio securities, monitors wash sales and matches purchases and sales of portfolio securities to minimize the tax effects of portfolio transactions. Those circumstances also include the operation of money market funds, in which manager of managers, multi-style investing is not likely to add value. In both cases, however, the investor continues to rely on the principal adviser to oversee and objectively evaluate the single subadviser, and to replace that subadviser if necessary in the best interests of the fund's shareholders.
Requiring such funds to hire multiple subadvisers could lead to three results, none of which would benefit investors. Such funds would hire multiple advisers merely to fit within the exemptive relief; such funds would no longer be offered; or such funds would suffer from having to follow different administrative procedures than those of other funds of the same fund group.
Fund shareholders benefit from consistent administrative procedures. Administrative expense and complexity are reduced if all funds within a manager of managers fund complex are operated pursuant to the same procedures. Consistent administration processes, procedures and contractual arrangements reduce the possibility of errors or inconsistencies. Moreover, consistency of operations promotes investor understanding. If some funds within a manager of managers complex operated under manager of managers fund exemptive relief while others do not, investors' understanding would suffer. A confusing and complex fund structure necessarily results in complex disclosure and potential confusion, neither of which is helpful to investors.
The need to operate different portions of the same complex under different rules would be expensive and inefficient, as would the alternative of creating separate complexes - one for manager of managers funds and one for single managed funds. The duplicative expenses of two boards of directors, multiple redundant (and possibly inconsistent) board meetings, registration expenses, audit, legal and custody fees would far outweigh any suggested benefit derived from requiring every fund in a manager of managers fund complex to have a minimum number of subadvisers.
A far more efficient solution would be for the Commission to consider on a case by case basis whether a manager of managers fund's operations are consistent with the premises and representations set forth in the rule. For instance, is the principal adviser actually selecting and supervising the subadvisers in a fund with only one subadviser? What actions demonstrate that activity? A requirement that all manager of managers funds have multiple subadvisers would not promote the best interests of investors, as its premise mistakenly substitutes an arithmetic test for the fundamental premise of a manager of managers approach to investing.
VI. RESCISSION OF ORDERS.
The Proposing Release states that upon the adoption of Rule 15a-5, the Commission intends to rescind the Orders. We are unaware of any precedent for a Commission rule to supersede previously granted exemptive orders. We note that there is no indication that the Commission's issuance of the Orders was inappropriate and the Orders contain at least the same investor protections as the Proposed Rule. Therefore, we oppose the Commission's proposal to rescind the Orders. Additionally, if the Commission rescinds the Orders, does that preclude a fund from filing subsequent exemptive applications to operate as a manager of managers fund other than in accordance with the terms of the Commission's rule? As has been the case with other Commission rules addressing topics which have previously been the subject of exemptive orders, recipients of Orders should be allowed to choose to continue to operate under their Order or to operate under Rule 15a-5. However, if the Commission decides to rescind the Orders, the adopting release should clarify that funds currently operating pursuant to an Order are not required to obtain shareholder approval to operate as manager of managers funds pursuant to the final rule.
You have asked how competition would be affected if the Commission does not rescind the Orders.
To our knowledge, no competitive issues have been raised regarding allowing existing Order recipients to choose to operate under their Order or under the rule. Because the conditions of the Orders are substantially the same, and in some cases more extensive, than those of the Proposed Rule, we do not believe that there would be an effect on competition if the Commission does not rescind the Orders. The conditions of the Orders themselves vary and this has not, to our knowledge, raised any competitive issues. The rescission of the Orders may itself have a competitive impact by changing the terms under which existing manager of managers funds were structured and established in reliance on the Orders.
VII. DISCLOSURE UNDER ITEM 6(a)(2) (formerly Item 5(c)) of Form N-1A.
The Funds are currently operating under a no action letter7 (the "No Action Letter") in which the Commission staff stated that it believed it would be sufficient for FRIMCo to make Item 5(c) (now Item 6(a)(2)) disclosure regarding the following:
We suggest that the Commission clarify in the adopting release that manager of managers funds are entitled to continue to rely upon the No Action Letter, or revise the Proposed Rule to amend Form N-1A to incorporate the provisions of the No Action Letter.
VIII. CONTRACT TERMINATION.
The definition of subadvisory contract provides that a subadvisory contract be terminable at any time by the principal adviser on not more than 60 days written notice. We would suggest that this definition be amended to provided that (1) subadvisory contracts are also terminable by the fund and (2) subadvisory contracts be terminable without the payment of any penalty at any time by the principal adviser or the fund immediately upon written notice to the subadviser. Once the principal adviser has made the determination that it is in the best interests of the fund and its shareholders to terminate a subadviser, the principal adviser should be able to effect this termination immediately, without a 60 day notice period. It is in the best interests of shareholders for the principal adviser and the fund to have the ability to terminate any subadvisory contract immediately upon written notice.
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Please call the undersigned at 253-591-3473 if you have any questions regarding this comment letter.