FPA Government Relations Office
1615 L Street, N.W., Suite 650
Washington, D.C. 20036
Web site: www.fpanet.org
By Electronic Mail
February 7, 2003
Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: Release Nos. 33-8164; 34-47023; IC-25870; File No. S7-51-02; Shareholder Reports and Quarterly Portfolio Disclosure of Registered Management Investment Companies
Dear Mr. Katz:
The Financial Planning Association ("FPA")1 appreciates the opportunity to file the following comments concerning the above referenced rule. As a general matter, the FPA strongly supports the proposed rule, which in large part addresses the concerns expressed by FPA in its June 28, 2000, petition requesting the Securities and Exchange Commission ("SEC" or the "Commission") adopt a mutual fund disclosure rule increasing the frequency of disclosure of equity holdings, among other things.2 FPA strongly commends the Commission for proposing changes that will significantly improve the disclosure of mutual fund portfolio holdings to shareholders and their investment advisers via the Internet, thus making style drift3 in mutual fund holdings much easier to track, and without significantly burdening the funds with new and unnecessary distribution costs, or passive shareholders with unwanted mail.
FPA believes there are two aspects of the proposal that could be amended to greatly enhance disclosure to advisers and investors: 1) increase the frequency of reporting of equity holdings from quarterly to monthly; and 2) add disclosure of soft dollar and related brokerage costs to the expenses disclosed in the hypothetical illustration or in some other meaningful disclosure format.
Currently, the proposed rule increases the frequency of reporting of equity holdings from the current maximum reporting period of eight months (including the 60-day time lag for reporting) to five months, including retention of the 60-day time lag. In terms of the technological capability of "real-time" reporting currently emphasized in general by the Commission, and that is readily available specifically with respect to reporting of a fund's equity shares, we believe that 150 days remains too long of a period to provide meaningful disclosure, and response by shareholders and their advisers, to new positions in a mutual fund. For example, if a mutual fund opted to delay reporting until the end of the fifth month as proposed under the rule, and disclosure occurred shortly after the financial planner had completed his clients' portfolio rebalances, the most recent fund information would be up to eight months old by the time the subsequent quarter's rebalances were made. We believe that a reasonable disclosure requirement of 30 days, along with a maximum 30-day time lag for reporting via the Internet, would improve advisers' and shareholders' ability to rebalance portfolios in a more timely fashion to avoid style drift. In addition, more frequent reporting would also help discourage funds from using periodic "window dressing" to enhance the appearance of a fund manager's stock-picking expertise.
We do not believe that a two-month reporting delay would materially affect a fund's ability to build or reduce positions in equities, or create a problem with `front-running' by speculators. We understand that many fund managers today run individual separate account portfolios that effectively replicate the top 30 to 50 holdings in their mutual fund portfolios, thus making their trading strategies "transparent" for anyone who wants to put more effort into accessing a manager's trading strategy. Therefore, a monthly disclosure requirement with a 30-day time lag for reporting should not cause any significant additional burden and would provide investors and their financial advisers with much more relevant information.
With respect to disclosure of a fund's expenses, FPA recognizes and supports the efforts of the Commission over the years to increase investor understanding of this critical and often complex factor in mutual fund selection. However, FPA believes that brokerage costs and related soft dollar expenses related to brokerage expenses should be included in the "actual current period expenses"4 to be disclosed to shareholders. Estimates of brokerage costs to shareholders may add as much as 70 or 80 basis points to overall expenses, according to certain studies that we have seen.5 We understand that the General Accounting Office ("GAO") is interested in reviewing brokerage costs, among other disclosure practices of mutual funds, when it makes recommendations for changes pursuant to a recent congressional request.
At a minimum, we believe that brokerage and related soft dollar costs should be incorporated into the rule proposal, which requests comment on disclosing to shareholders fund expenses borne by investors during the reporting period. However, we do not endorse this approach. It appears that the Commission is interested in expanding the current prospectus disclosure of the hypothetical expense table related to a $10,000 investment by adding two separate calculations based on (1) prior performance of the fund; and (1) an assumed 5 percent annual rate of return to be reported periodically to shareholders in the future. We are not aware of any evidence or studies confirming the utility of the current disclosure to shareholders, and at worse, will make periodic shareholder reports more confusing to understand.
We would prefer an alternative approach, as requested in the Proposing Release. FPA supports retaining the current disclosure of fund expenses as a percentage of net asset value, which is a simpler and more straightforward way for investor to understand individual shareholder costs. As mentioned, we believe a critical element has been missing to this expense disclosure, though, which are the transaction-related fees incurred by the fund. These are not included in the Overall Expense Ratio ("OER"), and not otherwise readily available to shareholders. It is true that funds are currently required to disclose stock turnover rates, and this may be a helpful indicator of a fund's brokerage costs, particularly in tax planning, but not investment management. However, cross-trades between funds and widely varying transaction costs do not provide an accurate picture of brokerage costs based on turnover rate. We therefore recommend that actual brokerage and related soft dollar expenses be added to the OER for a reportable period, or broken out in a separate category in percentage terms for the same period.
We have the following additional comments concerning the use of a summary portfolio schedule in response to certain questions posed in the rule:
1. Which holdings should be disclosed?
FPA supports the proposal to require summary disclosure of a fund's 50 largest holdings and each investment that exceeds 1 percent of the fund's net asset value. Requiring the disclosure of more holdings than those set forth in the proposed rule would make the summary reports too complex for the average shareholder without affording any commensurate value.
2. In what order should the holdings be listed?
FPA supports identifying holdings in order of descending value. Portfolio holdings are typically displayed that way in most fund and third-party research reports. Shareholders are likely to be most interested in obtaining information about the fund's largest holdings upfront before seeing other information. There would appear to be no benefit to adopting a category approach to the order of listing.
3. Should funds be permitted to use the summary portfolio schedule for other investments?
FPA supports summary disclosure of other investments in a fund. Such disclosure would provide the shareholder with a substantive overview of the fund's assets, especially since certain other investments, such as short positions, are very important to managers. Presenting these other investments in the aggregate, but by investment category, would suffice and, if needed, could be presented as an addendum to the summary portfolio schedule.
4. What media should be used to present summary portfolios (e.g., websites, mail)?
FPA supports permitting a fund to place its summary portfolio schedule on its website, with the caveat that if an investor requests a hard copy, it should be made available through the mail.
5. Would graphic presentation of fund holdings be useful?
FPA believes that graphic presentation of fund holdings can be useful for shareholders, but such a presentation should be optional.
6. Will the SEC's proposed disclosures lead to better cost comparisons among funds and between funds and other investment vehicles? How would the proposed disclosure affect the cost of competition among mutual funds and between mutual funds and other savings and investment vehicles, such as bank certificates of deposit? Will mutual fund investors understand that the ongoing costs shown have already been deducted from returns shown by a fund?
While conceding that the answer to most of these questions depends upon the financial sophistication of the investor, the disclosures set forth in the proposed rule should go a long way toward making more accurate comparisons available and should, accordingly, bring greater investor attention to funds that have lower costs. At the same time, while the proposed rule goes a long way to addressing concerns about the impact of fund expenses on investment returns, shareholders need to be aware of a variety of other factors that should be addressed in selecting the most suitable mutual fund, including volatility and longer-term mutual fund performance.
In conclusion, FPA strongly supports the proposed rule. It will provide mutual fund shareholders with transparency without overly burdening the fund industry nor negatively impacting fund trading strategies. The option to use summary portfolio schedules would provide fund managers with some flexibility in how they present their reports while providing shareholders with a clearer picture of the fund's current trading practices. We strongly encourage the SEC to consider monthly, as opposed to quarterly, reporting, and that the lag time on the reports be limited to 30 days.
We would be pleased to provide any additional information requested by the SEC. Please do not hesitate to call the undersigned at (202) 626-8770.
Duane R. Thompson
Director of Government Relations
|1|| The Financial Planning Association is the largest organization in the United States representing financial planners and affiliated firms, with approximately 29,000 individual members. Most are affiliated with registered investment adviser firms registered with the Securities and Exchange Commission ("SEC"), state securities administrators, or both. FPA maintains administrative offices in Atlanta and Denver, and is incorporated in Washington, D.C.
|2|| See June 28, 2000, rulemaking petition to the Commission.
|3|| Style drift is an industry term used to describe a conflict between the actual equity holdings and the stated investment objectives of a mutual fund. Style drift can adversely affect portfolio performance when the adviser relies primarily on an asset allocation strategy to assist clients in reaching their investment objectives.
|4|| See Release at 16.
|5|| See John C. Bogle, "Success in Investment Management: What Can We Learn From Indexing," Oct. 26, 2000, at http://www.vanguard.com/bogle_site/october262000.html, where Bogle estimates the an equity fund's transaction costs to be 70 basis points of average assets. See also Russ Wermers, "Mutual Fund Performance: An Empirical Decomposition into Stock-Picking Talent, Style, Transactions Costs, and Expenses," the Journal of Finance, Vol. LV, No. 4, at 1690 (August 2000) who states that mutual fund equity portfolio costs of 1.6 percent in the study are split almost evenly between expense ratios and transaction costs.