What’s in a Name? Possibly Too Much, or Not Enough

SEC says today’s Names Rules may not be effective in stopping the implementation of misleading fund names.

The Securities and Exchange Commission (SEC) is soliciting public comment pertaining to the Names Rule, in addressing whether the stipulation is effective in its purpose of avoiding “misleading investors about its potential holdings and risks” when funds are named.

“The name of a registered investment company or a business development company (a ‘fund’) is a tool for communicating with investors. It is often the first piece of fund information investors see and, while investors should look closely at a fund’s underlying disclosures, a fund’s name can have a significant impact on their investment decision,” the SEC said in a report.

The procedure for assembling the framework was launched with a 60-day solicitation period for public comment on whether the existing Names Rule is effective in prohibiting funds from using names that are materially deceptive or misleading. The final rule requires a fund to invest at least 80% of its assets in the manner suggested by its name.

The SEC has found several challenges in adhering to the current Names Rule since its implementation in 2001. One of the problems is that funds increasingly use derivatives and other financial instruments that provide leverage, and “because the Names Rule is an asset-based test, it may not be well-suited [to] derivatives investments that provide significant exposure to a “type of investment.”

Convertible securities are also posing a challenge for the rule, since these types of investments harbor both debt and equity characteristics that could potentially diverge from a fund’s implicit strategy implied by its name.

The trending theme of environmental, social, and governance (ESG) investing also is posing a considerable challenge, with many different funds simply putting “ESG” in their name. However, ESG does not determine asset-level holdings, thus deviating from the intended purpose of the Names Rule.

Todd Rosenbluth, director of mutual fund and ETF research at CFRA, cited the $1.2 billion First Trust Utilities AlphaDEX ETF (FXU) as an example of a fund that might surprise some investors, Investment News reported.

“The fund has a nearly 30% allocation to telecom companies, including AT&T, Verizon, and T-Mobile that are not utilities,” he said. “An investor buying this fund would likely be surprised to find AT&T is one of the larger holdings.”

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