Brent Sheather: Managed fund investment statements

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Early in April, NZ's chief regulatory body of the financial sector, the Financial Markets Authority (FMA), published its revised guidance for the issuers of all new securities. The guidance chiefly relates to what should be included in a prospectus for new share issues and investment statements for managed funds. This report looks at the guidance for managed fund investment statements. The investment statement is where Mum and Dad contemplating buying a managed fund or KiwiSaver product needs to go to find out details of fees, performance etc. As this column has illustrated over the years finding information about these key variables such as what its costs are is currently problematic for retail investors. Imagine going to buy a car and not being told the price. It's a ridiculous situation.

The FMA document attempts to address this problem but the FMA has been vigorously lobbied by fund managers who say that complying with lots of legislation will cost more. Their revised guidance thus represents a less rigorous attempt at making sure investment documents are useful. This is potentially of concern looking at the sixty different submissions on the FMA's first attempt you don't see many advocating the position of retail investors although the FMA advises that it had a number of one on one meetings with groups such as Consumer and the Shareholders Association. The submission by Consumer Magazine was particularly disappointing in that it didn't even comment on the investment statement issue. Sue Brown, the FMA executive in charge of this area, said the FMA's objective was to make sure that all relevant information was included in the relevant documents. Okay, let's have a look at what the FMA has come up with and compare that with the same sort of documents in the USA.

First up what is an investment statement supposed to do. Section 38D of the Securities Act says: "The purpose of an investment statement is to provide key information that is likely to assist a prudent but non-expert person to decide whether or not to subscribe for securities".

The FMA also wants the investment statement to be clear, concise and effective using plain language, logically ordered and highlighting important information. In the past details of all the fees payable were often spread over four or five pages in a 100 page document. One had to be a forensic accountant to know what one was paying.

So this effort from the FMA sounds like a big step forward but further on the FMA document says that an investment statement doesn't need to have a "Key Information" section. This is at sharp variance with best practice in the USA where details of fees and performance need to be set out in the first few pages of the key disclosure document for a managed fund. Reality is that many retail investors can't be bothered with due diligence and instead rely on their adviser to look after their investments. Given that many financial advisers in NZ are paid by the fund manager they aren't highly incentivized to minimize fees or indeed bring them to the attention of the investor.

Of more concern however is the failure to adequately prescribe how performance is disclosed to investors. To see the extent to which potential NZ investors are kept in the dark we compare the requirements under NZ law with what US investors get, using an actual managed fund sold to US retail investors by the second largest fund manager in the US, Fidelity.

The FMA's document says the managed fund's prospectus (and presumably the investment statement) must disclose performance over each of the preceding 5 years in a clear, concise and effective way. That's nice but in the USA however the equivalent of the investment statement is required to provide not only the performance of the fund but also that of a relevant benchmark. This latter requirement makes the information far more "effective" as prospective buyers can see not only whether the fund manager is any good has he/she added value or not but most importantly whether the fund is a good proxy for the asset class it is supposed to represent. The FMA "Effective Disclosure" document then goes on to say "A fund's financial performance may be affected by a number of factors as well as investment returns such as:

* level of fees charged to the fund;
* fees and expenses rebated to the fund;

You should consider identifying these factors and disclosing their nature and effect on investment performance. Not doing so could cause the prospectus to be misleading."

Shall we read that again: "You should consider identifying these factors." Not in the US over there you have to disclose this information and then show exactly how it will impact performance or else, like on that popular board game, you "go directly to jail". The following is an excerpt from a US managed fund's offer documents showing how performance and fees are disclosed to US investors. To see an example of a US managed fund offer document click on this link.

The FMA has to be careful that it doesn't rewrite the law so at this stage can only "guide" fund managers towards what it sees as good practice. It has for example said that there should be a summary page but fund managers are not compelled to oblige. One imagines that if the FMA did get tough fund managers might scuttle off to the appropriate politician to complain. The bottom line however is that the purpose of the investment statement is to "provide information to assist a person to decide whether or not to buy a managed fund". By excluding details of the benchmark performance and all of the costs associated with investing in the fund the new investment statement will still not do its job. This is disappointing because we only have to look to the USA to see what "best practice" looks like. It will be interesting to see if any enlightened fund managers voluntarily include benchmark information. Don't hold your breath.