February 23, 2004
Mr. Jonathan G. Katz, Secretary
Re: Concept Release: Request for Comments on Measures to Improve Disclosure of Mutual Fund Transactions (file no. S7-12-03)
PricewaterhouseCoopers LLP appreciates the opportunity to comment on the Commission's Concept Release: Request for Comments on Measures to Improve Disclosure of Mutual Fund Transaction Costs (the "Concept Release").
We have included in this letter responses to certain of the specific questions raised by the Concept Release. We do not believe that piecemeal increase in disclosures, addressing individual issues separately, is the solution to providing investors and other users with the information they need to effectively manage their money. Instead, we believe the focus should be on the broader objective of transparency. Incremental disclosure is not equal to transparency, and can, over time lead to a patchwork quilt of disclosure with no increase in depth of investor understanding. While transparency is not something that can be achieved by legislative or regulatory means and involves issues beyond the scope of the Concept Release, we believe the Concept Release is a useful framework for evaluating proposed disclosure requirements.
Disclosure, while being a necessary condition for investors to get the information they need, does not, in itself, constitute transparency. Effective transparency requires a fund to provide much of the information that management itself finds useful for internal decisions and to present that information in a form that can be easily accessed and understood by external stakeholders, including investors and analysts. Relevance, timeliness and user-friendliness are essential attributes for effective transparency.
To achieve relevance, one should recognize that an investor is primarily focused on generating asset growth and income consistent with an acceptable risk level. For investors, information relating to a fund's operations, including the fund's transaction costs, becomes most relevant when it is provided in the context of how it affects the fund's risk profile and total return. To achieve a higher rate of return, a fund may very well be able to justify higher transaction costs, and this trade-off should be considered when evaluating financial results and providing information to investors. Accordingly, providing a narrative and quantitative analysis of how portfolio transaction costs affect a fund's total return is more useful to an investor than a disclosure without context of the gross amount of transaction costs paid by a fund or disclosure of the portfolio turnover rate.
In our recent White Paper Communicating the Value of your Funds: a New Model for Transparency in Fund Reporting, which we attach hereto, we suggested a summary table illustrating the impact of fund expenses and transaction costs on fund total return. This information enables an investor or other user to evaluate transaction costs and other key components in the context of their impact on the fund's total return, evaluate the impact of the variability of transaction costs on the fund's total return from period to period and aid comparisons of the impact of transaction costs and other components of total return among funds.
While discussing the overall mix of investor disclosure requirements is beyond the scope of the Concept Release and this comment letter, we believe that a more robust Management's Discussion of Fund Performance might well be a useful forum for providing investors and other users the impact of transaction costs and fund expenses on a funds' returns. The purpose of the fund performance discussion is to enable investors and other users to understand what fund management viewed as the matters that materially affected total return during the period. Fund expenses and transaction costs should be discussed in that context. Additional and more precise measurements of costs will not correlate in increased understanding of fund performance by investors unless it is presented in the context of total return. Rulemaking from the commission mandating more robust discussion of fund performance that focuses on the drivers of a fund's total return and reduces boilerplate comments would contribute significantly to improving transparency of funds' total return and fund expenses including transaction costs.
We have included as Appendix A, responses to certain questions in the Concept Release.
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We appreciate the opportunity to express our views and would be pleased to discuss our comments or answer any questions that the staff may have. Please do not hesitate to contact Chip Voneiff (312-298-4815) or Richard Grueter (617-530-7414) regarding our submission.
Quantifying Transaction Costs (Questions 1-3, 5, 6, 8, 10, and 11)
In general, we support increased quantification of reliable information regarding transaction costs if this information can be provided in a manner that gives investors and other user more complete information on which to base their investment decisions. In determining which information to provide to investors, we believe the primary focus should be on what information is most useful in making investment decisions, rather than focusing on the information that is easiest to quantify.
We believe focusing solely on numerical information and piecemeal disclosure is not sufficient, and that providing qualitative discussion of transaction costs relevant to a fund's performance is necessary to allow the investor to analyze such information in a meaningful way. The qualitative discussion should serve two purposes - first, to put the quantitative information into context and, second, to provide additional information that may be relevant but is not easily quantifiable. Information describing transaction costs should be in Management's Discussion of Fund Performance (MDFP), and should focus on management's view of the impact of transaction costs relative to the return of the fund. This framework would, for example, provide management with a vehicle to describe how their decisions about such issues as frequency of trading and use of soft dollars contributed to the achievement of the fund's objectives.
Current disclosures required in a fund's prospectus and statement of additional information such as gross commission dollars and portfolio turnover provide numerical information to investors. However, there is no present requirement to provide any discussion as to how such information correlates to overall fund performance. Disclosure of these numerical measurements in the absence of other information may lead investors to believe lower commissions or portfolio turnover result in higher returns when, in fact, lack of certain portfolio transactions may have resulted in lower returns to the fund if, for example, transactions were not initiated during favorable market conditions.
We are concerned that a requirement to quantify and disclose certain transaction costs but not others (i.e. quantify brokerage commissions but provide no information on spread trades) may provide an incomplete overall picture of the impact of a fund's portfolio management strategy and associated costs to the investor. However, we are equally concerned that a requirement to quantify certain types of transaction costs such as market impact costs and opportunity costs, which are prone to a high degree of subjectivity and complexity of measurement, would be difficult to calculate reliably and consistently and would not provide meaningful information to investors. A more holistic approach that includes numerical information where it can be reliably and consistently measured, along with discussion of the impact of various trading strategies and their relevance to the fund's total return, would provide the most meaningful and complete information to investors and other users.
Providing too much numerical information to an investor can also be counter to the goals of transparency. Increased volume of information that is not put in proper context in terms of its effect on fund performance may not be helpful to investors but rather may result in information overload. For example, while market impact and opportunity cost measures would add complexity to the information provided to investors, it is not clear that there would be a sufficient cost benefit unless, as we described earlier, the measures can be put into terms that directly explain the impact on total return to shareholders.
We believe that transaction costs should not be included in the fund's expense ratios or fee tables in the prospectus. Disclosure of expense ratios in the prospectus that is not consistent with that presented in the fund's financial statements may create more confusion for investors attempting to understand differing ratios rather than improving their understanding. In addition, expense ratios as currently reported in financial statements and prospectus fee tables are based on historical operations costs that are relatively predictable, and, therefore a good indicator of such costs in the future. Portfolio transaction costs lack this element of predictability, as they are driven by many factors such as changes in portfolio management or strategy, shareholder inflows and outflows, and general market conditions, all of which are likely to vary significantly from year to year. Accordingly, historical portfolio transaction costs cannot necessarily be expected to provide investors with an accurate picture of future costs, and therefore should not be included in prospectus fee tables or financial statement ratios but rather quantified as a separate element of fund performance disclosed on a historical basis. Combining these two types of expenses in a single ratio will make the traditional operating costs less transparent. Any incremental disclosure should be in the MDFP, and focus on transaction costs that can be reliably measured, supplemented by qualitative discussion by management for context.
Accounting Issues (Questions 13 and 14)
Current accounting for commission costs follows the guidance in the AICPA Audit and Accounting Guide, Audits of Investment Companies, which requires brokerage commissions and other charges that are part of securities purchase transactions be included in investment cost. This treatment is consistent with generally accepted accounting principles for other entities. We believe that any changes to the treatment of brokerage commissions and portfolio transaction costs for financial statement purposes would be most appropriately addressed for all entities through changes to generally accepted accounting principles by the Financial Accounting Standards Board, rather than modification of the Commission's requirements for registrants in one specific industry. This approach has the effect of maintaining consistency in accounting for financial statement purposes between funds that are regulated by the Commission and funds that are not, as well as in the broader conceptual framework among different financial services enterprises that have large investment portfolios (e.g., insurance companies and banks). If additional information is considered necessary for investors of public investment vehicles, we believe such information should be required as additional disclosures included in MDFP.
Additional Information about the Level of Transaction Costs (Questions 16-18, 19 20, and 22)
We believe that disclosure of transaction costs under broad standards or general categories (such as "high", "average", "low", etc.) would be difficult to measure and apply consistently and would be confusing in comparing funds without the benefit of additional quantitative or qualitative information to provide a proper context about the nature of fund transactions and the markets in which such transactions are executed. In addition, we are concerned that disclosure under such broad standards or categories may lead to general discussions of fund transactions without providing specific information on a fund's transaction costs and their impact on a fund's returns.
We do believe that existing portfolio turnover disclosures provide useful insights to investors that may not be limited solely to information on transaction costs. Portfolio turnover is a meaningful statistic that may also provide investors with information on portfolio management style, portfolio trading volumes, and tax efficiency of funds. However, portfolio turnover is an imperfect measure of transaction costs, whose usefulness to investors could be enhanced if additional information is provided to investors to allow them to understand the impact that turnover has on the fund's overall performance.
As we have previously described, we do not believe the existing requirement to disclose commissions paid provides investors and other users with context about how transaction costs have affected their total returns.
We believe that disclosure of average daily gross and net flows may be useful for investors it if is presented in a meaningful way that explains how such flows have affected the fund's portfolio management, performance and transaction costs.
We do not believe that disclosure of average commission rate per share should be reinstated as a numerical measure. Past experience has shown that this disclosure did not provide meaningful information, as the numerical measure in and of itself does not provide information as to whether commissions are being used effectively or ineffectively by the fund, and, in fact, serves as an illustration of the problems of providing piecemeal information without discussing in the proper context its relevance to investors. Further, transactions in securities traded on non-U.S. exchanges and other securities with unusually high or low per share commissions can and did affect the disclosure's comparability from fund to fund.