The Canadian fund industry is lobbying against new securities regulations that require mutual fund prospectuses to compare past performance to market benchmarks. The mandatory references to market indexes are among the more controversial aspects of the legislation, National Instrument 81-101. The sweeping new rule took effect on Feb. 1 and is coming into force gradually this year as fund companies revise their prospectuses and introduce new funds.
Forcing fund companies to compare the past performance of their funds to market benchmarks is "one of the areas we have problems with," said Lori Lalonde, senior counsel for the Investment Funds Institute of Canada (IFIC). Though it is generally supportive of the new disclosure rules, the trade group would prefer to see funds required to be compared to similar funds in the same category, said Lalonde.
One of the main reasons for IFIC's objections is the current composition of the main Canadian market benchmark, the Toronto Stock Exchange 300 composite index. At the end of the first quarter, two stocks in the TSE 300 - Nortel Networks and BCE - had weightings of 19 percent and 14 percent, respectively, of the index.
IFIC contends that the TSE 300 is an inappropriate benchmark because actively-managed funds are not allowed to invest fully in the component stocks. Apart from index funds, which receive special exemptions from regulators, funds are not allowed to invest more than 10 percent of their assets in any one stock.
From a marketing point of view, comparing fund performance to the market index puts most Canadian equity funds in an unflattering light. In 1999, Nortel and BCE, an affiliated holding company, accounted for most of the index's return.
As a result, most actively-managed funds lagged the index. Only 36 of 216 diversified Canadian equity funds beat the TSE 300's total return of 31.7 percent last year, according to BellCharts, a fund measurement service based in Toronto.
Securities regulators oppose the use of category averages on the grounds that fund companies might try to select figures that put their funds in the most favorable light.
"That's really open to cherry-picking, in my view," said Rebecca Cowdery, manager of investment funds at the Ontario Securities Commission.
Cowdery said that by requiring comparisons to market indexes, regulators are trying to give investors general information about how the markets have fared.
"It's not designed to be a benchmark for the performance of the fund," she said.
Apart from the controversy over the use of market indexes, the new prospectus rules have met with general support from the industry. The new regime streamlines the disclosure process, since there is no longer a requirement to deliver financial statements to all new investors at the time of sale. Financial statements and the funds' annual information forms must be given only to investors who specifically request them.
However, additional details must now be disclosed in prospectuses. These include a fund's top 10 holdings, past performance over calendar year and compound annual periods, its distribution and expense-ratio history, and portfolio turnover. The new prospectuses also contain tables, using hypothetical examples, that illustrate in dollar terms the impact of expense ratios and sales commissions.
"Overall, we're fairly happy with it," said Lalonde of the IFIC. She said the most important change in the prospectus is the requirement that it be drafted in plain language. Along with the use of charts and graphs, this will make it easier for investors to compare mutual funds, she said.
The first of the new style prospectuses was issued at the end of March by McLean Budden, an investment management company and direct seller of mutual funds based in Toronto that recently lowered its management fees. Douglas Mahaffy, president and CEO of McLean Budden, said his firm welcomed the trend to greater disclosure of fees.
The IFIC is seeking to expand its membership to include sponsors of managed products other than mutual funds, IFIC officials say.
Among the types of new members that it is targeting are managers and distributors of pension funds, labor-sponsored venture capital corporations, and segregated funds offered by insurance companies.
To help attract new members, the trade group has revamped its organizational structure. Effective Feb. 23, it eliminated its manager and retail distributor divisions, each of which had its own council of governors.
Instead, there is a single, expanded board of directors, which held its first meeting in April. The board can have as many as 33 members, up from 19 previously.
At the same time, IFIC changed its membership categories. It ended the distinction between manager members and retail distributor members, while continuing its practice of giving non-voting affiliate member status to firms such as legal, accounting and other service providers.
In a concession to members in the mainly French-speaking province of Quebec, IFIC's reorganization provides for continued recognition of IFIC regional councils.
While IFIC is a national organization, the Quebec council contributes to public awareness of the industry in Quebec, as well as providing a "Quebec perspective" on national issues being worked on by IFIC, said John Murray, vice president of corporate affairs at IFIC.