Consultation on use of potentially misleading names comes as market developments impact long-standing rule
Earlier this month, the U.S. Securities and Exchange Commission (SEC) launched a consultation on its current requirements to limit the use of potentially misleading fund names.
“Fund names are often the first piece of information investors see and they can have a significant impact on an investment decision,” the regulator said in a note dated March 2.
The SEC adopted rule 35d-1, also known as the “Names Rule,” in 2001 to prohibit the use of materially deceptive or misleading fund names. Under the rule, a registered investment company or business development company with a name suggesting that a fund focuses on a specific type of investment is required to invest a minimum of 80% of its assets accordingly.
“This request for comment is another important step in our efforts to better inform and protect Main Street investors and improve the investor experience,” said SEC Chairman Jay Clayton.
How much does a fund’s name matter? Quite a lot, according to a paper published in the Journal of Finance in 2005. Researchers from Purdue University and Virginia Tech looked at a sample of almost 300 equity mutual funds that made a style name change — alterations that resulted in the addition of terms like “Value,” “Growth,” “Small,” or “Large” — during a period covering April 1994 until July 2001.
“Name changes for these funds appear to be motivated by reductions in fund inflows prior to the name change,” the authors said, noting that new names were likely to be either associated with a current “hot” style or distant from a currently “cold” style.
“We find that the year after a fund changes its name to reflect a current hot style, the fund experiences an average cumulative abnormal flow of 28 percent, with no improvement in performance,” they said.
After more than a decade, the tendency among fund providers to name products according to popular trends hasn’t vanished. Certain ETFs launched in 2017 and early 2018 had labels suggesting they were investing in the hot-at-the-time blockchain trend, but were in fact holding basic technology stocks. More recently, some have taken advantage of a surge in green investing by launching funds that are ESG in name only.
“Market and other developments since adoption of the rule, such as increasing use of derivatives, impact the rule's application,” the SEC said. “The Commission welcomes engagement from funds, their advisers, investors, and other market participants on these and related issues.”