The Vanguard Group, Inc.
February 11, 2003
Jonathan G. Katz, Secretary
RE: Shareholder Reports and Quarterly Portfolio Disclosure of
Dear Mr. Katz:
The Vanguard Group Inc. ("Vanguard")1 appreciates the opportunity to comment on the Securities and Exchange Commission's recent proposal to improve the quality of shareholder reports for mutual fund investors.2 Vanguard has long advocated many of the Commission's proposals because they will provide mutual fund shareholders with useful information in a cost-effective manner. We urge the Commission to adopt the rule and form amendments substantially as proposed. In particular:
I. Summary portfolio holdings disclosure in shareholder reports
We strongly support the Commission's proposal to permit funds to include a summary schedule of portfolio holdings in shareholder reports in lieu of the complete schedule that is currently required. The proposal would require disclosure of a fund's 50 largest holdings in unaffiliated issuers in descending value and each investment that exceeds 1% of net asset value. Summary portfolio holdings schedules in shareholder reports will enable investors to focus on a fund's primary holdings without getting bogged down in the fund's many smaller and less material holdings. Those shareholders who desire more information will have ready access to the full list of a fund's securities holdings.
A summary holdings schedule would be especially beneficial to investors in funds that hold thousands of securities, such as Vanguard Total Stock Market Index Fund. The Fund's most recent semi-annual report (for the period ended June 30, 2002) used 36 pages to report the Fund's approximately 3,500 individual holdings. The top 50 securities represented 43% of the Fund's net assets, while the bottom 2,000 collectively comprised only about 5% of net assets. The Fund invested less than 1/10 of 1% of its net assets in 3,300 different stocks. The identity of securities in which a fund has invested a minuscule fraction of its assets is of little or no value to the vast majority of shareholders. Nevertheless, we certainly support the Commission's proposal to make the full schedule available upon request for those shareholders who desire this level of detail.
Streamlining annual and semi-annual reports will save shareholders millions of dollars in printing and mailing costs. For example, by using a summary schedule, Vanguard Total Stock Market Index Fund can eliminate dozens of pages from reports sent twice a year to over 400,000 shareholders. The Commission's proposal will benefit all funds, not just those that hold thousands of securities. Funds with large numbers of shareholders will also reap significant savings. A summary schedule for the Vanguard 500 Index Fund, for example, would reduce the size of its shareholder report by only a few pages, but the cost savings would be significant given the large number of reports that the fund prints and mails. If adopted, this proposal will result in aggregate savings across the Vanguard complex of about $1.1 million annually in paper and printing costs, and an additional $1.4 million in postage, every penny of which will go into the pockets of the Vanguard Funds' shareholders.
The Commission requested comment on whether the summary schedule should list holdings in order of descending value or if there should be a different approach. Although we generally support disclosure of holdings in descending value, we recommend that the Commission grant funds the flexibility to sensibly disclose holdings in identifiable categories in the summary schedule. For example, a balanced fund's summary schedule should be allowed to disclose its top 50 holdings in asset categories - stocks, bonds, and cash. Further, funds should have the flexibility to appropriately categorize the top 50 holdings by industry or geographic region, with holdings in each category listed in order of descending value. A summary schedule that listed a fund's largest holdings in descending value and in identifiable categories not only would help investors focus on the key holdings of their fund, but also would enhance their understanding of the different kinds of investments in the fund's top 50. We note also that this flexible approach would avoid a conflict between Commission rules and the AICPA's generally accepted accounting principles ("GAAP") for investment companies.3
II. Quarterly disclosure of all portfolio holdings
The Commission's proposal would require funds to provide complete disclosure of portfolio holdings on new Form N-Q as of the end of their first and third fiscal quarters. (This disclosure would supplement the disclosure that occurs as of the end of a fund's second and fourth fiscal quarters on Form N-CSR.)
Although Vanguard has experienced virtually no demand from investors for complete portfolio holdings disclosure more frequently than semi-annually, we support the design of the proposal because it has been constructed to protect shareholders' interests in two critical respects. First, the proposal provides for a 60-day delay in reporting, which will protect funds and their shareholders from predatory trading practices such as front-running and free-riding. Second, the proposal does not require paper delivery of Form N-Q to fund shareholders, and therefore will not impose a significant new cost on all shareholders. Rather, Form N-Q would be available to shareholders through the SEC's EDGAR database, as well as through the fund's own website if the fund chooses to make the information available there. In short, we believe that the Commission's proposal appropriately balances the desire of a minority of investors for more frequent disclosure with the important goals of deterring predatory trading practices and keeping fund costs down for all shareholders.
III. "Miscellaneous securities" provision
The full schedule of portfolio holdings ("Schedule I")4 currently requires a fund to separately identify each "issue" it owns, with one important exception:
We recommend that the Commission incorporate the identical safeguard into the proposed summary schedule of holdings permitted in annual and semi-annual reports. This provision protects funds engaged in programs of buying or selling securities at the end of a reporting period or at the time of a filing from predatory trading practices. If the proposed reporting requirements are adopted without the same safeguards, the safeguards in the existing regulations will be moot and a valuable protection currently available to funds and their shareholders will be eliminated.
IV. Tabular and graphic presentation of portfolio holdings
We support the Commission's proposal to require shareholder reports to include a tabular or graphic presentation of a fund's portfolio holdings by identifiable categories, and agree with the Commission's proposal to give funds broad discretion about how to structure the presentation.5 Vanguard currently uses charts and graphs to describe the characteristics particular funds' investments.6 For example, Vanguard's international stock funds currently show the country and industry diversification, top 10 holdings, volatility measures (R-Squared and Beta), and general information about turnover rate and number of securities in the funds. Vanguard's municipal bond funds, on the other hand, show general holdings information, each fund's largest state concentrations, distributions by credit quality, and distribution by maturity. Each presentation is tailored to the characteristics of the fund involved. These presentations have been consistently well received by our shareholders.
It is critically important for funds to retain flexibility in selecting the characteristics to report. A broad, inflexible requirement about tabular and graphic presentation would not be in the best interests of shareholders because it could result in presentations that are not tailored to the fund that is the subject of the report. In certain cases, it could force funds to include presentations that are inappropriate under the circumstances. An inflexible requirement also could preclude funds from using innovative approaches in the future.
V. Exemption for index funds
The Commission has requested comment on whether to exempt index funds from the requirement to disclose portfolio holdings in shareholder reports, as long as the holdings are filed on EDGAR and made available to investors upon request and free of charge. Vanguard does not support such an exemption. Information about portfolio holdings is as useful to index fund shareholders as it is to shareholders of actively-managed funds. Most index fund investors know few, if any, of the securities included in their fund's target index. This is particularly true for less well-known indexes, such as those tracking mid-cap or small-cap stocks, foreign stocks, or bond markets. Index fund investors would benefit from receiving the same quality and quantity of information about portfolio holdings as shareholders of other funds. Therefore, whatever standards the Commission ultimately adopts with respect to portfolio holdings disclosure - including rules permitting summary schedules and requiring tabular and graphic presentations - should apply equally to index and actively-managed funds.
VI. Exemption for money market funds
We support the Commission's proposal to permit money market funds to omit the summary schedule of investments in securities of unaffiliated issuers from annual and semi-annual reports delivered to shareholders.7 The very short-term nature of money market securities makes disclosure of portfolio holdings for these funds almost obsolete upon delivery. In addition, money market funds must meet rigid requirements under rule 2a-7 as to credit quality, maturity, and diversification that render portfolio holdings information of little value to shareholders.
As the Commission noted in the Proposing Release, investors "may be less interested in the composition of money market fund portfolios than other types of funds."8 We agree, and therefore recommend that the Commission extend the proposed exemption for money market funds to the Form N-Q quarterly filing requirement. Because investors are largely uninterested in money market fund holdings, for reasons stated in the preceding paragraph, we believe that quarterly disclosure of money market fund portfolio holdings does not provide investors with useful information. The costs of preparing the schedule each quarter simply are not balanced by a commensurate benefit to shareholders.
VII. Fund expense disclosure
We support the Commission's proposal to require funds to disclose the cost in dollars associated with an investment of $10,000 based on actual expenses and actual returns. This figure would help shareholders calculate the actual expenses that they incurred in owning the fund. We, however, recommend that the Commission not adopt the proposal to report the cost in dollars associated with an investment of $10,000 based on actual expenses and an assumed return of 5%. We are concerned that an example based on an assumed return would unnecessarily complicate shareholder reports and confuse investors. Two expense examples could be particularly cumbersome for those reports containing multiple-class funds because such reports would have to disclose expense figures for each class.
The expense example that uses actual returns and expenses accomplishes the Commission's objective of informing investors about the expenses that they paid during the fiscal period. Although the second example is designed to help investors compare the costs of their fund to other funds (certainly a worthwhile goal), investors already receive this type of information in the fee table in the fund's prospectus. The prospectus, as an offering document, is better suited to this type of disclosure, and we see no compelling reason to duplicate it in shareholder reports. To the contrary, we think mixing a discussion of actual and assumed returns will be confusing to shareholders. In addition, since the comparative example in the prospectus (based on estimated expenses and an assumed rate of return)9 will necessarily differ from the comparative example in the shareholder report (based on actual expenses and an assumed rate of return), we think the potential for investor confusion is great.
The actual expenses shown in the shareholder report would reflect changes in the expense ratio over the period that the prospectus could not show. Also, the shareholder report disclosure would not reflect sales charges under the current proposal, even though prospectus expense disclosure does factor in sales loads. These discrepancies inevitably would confuse investors. An explanatory narrative could help alleviate this confusion, but as shown in the Commission's own example, it would be long and complicated. Given what we know about how investors read prospectuses and reports, we believe that a simpler approach focusing on actual returns and expenses would better serve investors.
VIII. Identification of non-income producing securities
The complete schedule of portfolio holdings currently required in annual and semi-annual reports must "[i]ndicate by an appropriate symbol each issue of securities which is non-income producing."10 The Commission is proposing to require identical flagging of non-income producing securities included in the summary schedule of portfolio holdings.11
We recommend that the Commission rethink its position requiring funds to flag non-income producing securities. In our view, this requirement is a relic of a bygone era. We think there continues to be value in flagging non-income producing fixed income securities, as this effectively would highlight defaulted bonds. However, we do not see equivalent value in flagging non-income producing equity securities. Whether or not a stock pays a dividend is not particularly significant or helpful to investors as compared to other possible attributes or characteristics. To place this information in context, consider whether it makes sense to highlight the fact that a particular stock paid no dividend when many other stocks in the portfolio paid dividends that were immaterial. Finally, we are concerned that highlighting this one attribute of a stock without explanation could confuse investors about the value of the information. Given the limited value of this information as it applies to stocks, and the fact that flagging this particular attribute in a portfolio holdings schedule is a labor intensive - and therefore costly - task, we believe the Commission should eliminate the requirement that funds flag non-income producing stocks in both complete and summary portfolio schedules.
IX. Disclosure regarding affiliates
Although not currently proposed, we recommend that the Commission revise the disclosure requirements concerning purchases, sales, dividends, and equity (net profit/loss) of investments in affiliates.12 For most fund companies, this disclosure requirement translates into providing additional information with respect to issuers in which a fund holds greater than 5% of those issuers' voting shares.13 These holdings are typically purchased and held in compliance with the diversification and other requirements under the Investment Company Act, and therefore, we question the benefit of providing historical data for these investments. We believe that by doing so, we might confuse shareholders or lead them to erroneous assumptions regarding this disclosure. We therefore recommend that the Commission eliminate this requirement for securities that are deemed to be issued by an "affiliate" solely because the fund owns more than 5% of the issuer's voting securities.
X. Management's Discussion of Fund Performance
We support the Commission's proposal to require that MDFP, which is currently required for all mutual funds other than money market funds, be included in annual reports to shareholders.14 We agree with the Commission that MDFP is a better fit with the "backward looking" information in shareholder reports than the "forward looking" information in prospectuses.
XI. Compliance date
The Commission proposes to require all fund reports to shareholders and all quarterly reports on Form N-Q filed for periods ending on or after the effective date of the amendments to comply with the amendments. We believe this time frame is unworkable unless the effective date is at least 120 days after adoption of the rules. Funds will need to reformat reports and make operational and systems changes, some of which may be complex, in order to comply with the new rules. In particular, new rules concerning fund expense disclosure in shareholder reports and quarterly portfolio holdings disclosure would require significant changes to Vanguard's current systems and procedures. We, therefore, do not believe it is feasible for all funds to make the necessary changes in less than 120 days.
XII. 13F revisions
The Commission has requested comment on whether to extend the period for filing Form 13F pursuant to Section 13(f) of the Securities Exchange Act of 1934. Currently, institutional investment managers must file Form 13F within 45 days after the end of each calendar quarter. We recommend that the Commission extend the filing period from 45 days to 60 days.
In the Proposing Release, the Commission expressly noted the potential downside of quarterly reporting:
As noted previously, we believe that the incorporation of a 60-day delay for portfolio holdings disclosure appropriately balances the desire of some investors for more frequent disclosure with the important goal of deterring predatory trading practices and protecting a fund's proprietary trading strategies. Since the Commission has determined that a 60-day lag is appropriate with respect to portfolio disclosure by funds, we believe it is appropriate to apply the same time frame with respect to portfolio disclosure by institutional investment managers. In addition, the extra protection from predatory trading practices afforded by extending the filing period from 45 days to 60 days may result in fewer managers using the confidentiality provisions to exclude information from Form 13F, resulting in more complete disclosure.
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We appreciate the opportunity to comment on this important proposal and commend the Commission for its effort to improve the content of shareholder reports. If you would like to discuss our comments, or if you have any questions, please contact me at (610) 503-4016, Barry Mendelson, Principal, at (610) 503-2398, or Christopher A. Wightman, Associate Counsel, at (610) 503-2320.
cc: The Honorable Harvey L. Pitt
John J. Brennan, Chairman and Chief Executive Officer
Sample Tabular and Graphic Presentation