The staff of the Securities and Exchange Commission (SEC) issued guidance reminding mutual funds, exchange traded funds, and other registered investment companies of the importance of reviewing their risk disclosures on an ongoing basis and considering whether these disclosures remain adequate in light of current market conditions.
Key Takeaways: The following are key considerations for investment companies:
- Monitor market conditions and their impact on fund risks on an ongoing basis and assess the impact of changing conditions on the fund and the risks associated with its investments. Funds should routinely engage in this practice as a normal part of day-to-day operations.
- Assess whether fund risks have been adequately communicated to investors in light of current market conditions. If a fund determines that changed market conditions have affected the risks associated with the fund, the fund should assess the significance of the change and whether it is material to investors. If it is material, a fund should consider whether its existing disclosures are adequate in light of the changed conditions.
- A fund that determines that changes in current market conditions have resulted in changes to the fund’s risks that are material to investors, and that its current disclosures do not adequately communicate the changes, should update its communications to investors. Means of communication to be considered include the prospectus (which, for example, would be updated when the fund determines that the risk disclosure in its prospectus would be materially misleading) and shareholder reports, as well as less formal methods, such as website disclosure and letters to shareholders.
- A fund that exposes investors to market, credit, or other risks, and whose name suggests safety or protection from loss, should reevaluate the name, as appropriate, to eliminate the potential for investor misunderstanding.
- A fund that uses investment strategies that employ derivatives should disclose material risks relating to volatility, leverage, liquidity, and counterparty creditworthiness associated with the fund’s trading and investments in derivatives. This disclosure should be tailored to the specific derivative instruments in which a fund invests or will invest principally.
- A fund’s adviser should consider providing information to the fund board on the steps taken by the adviser to evaluate fund risk disclosures and consider whether changes are appropriate to respond to changing market conditions or other developments.
Summary: Clear and accurate disclosure of the risks of investing in funds is important to informed investment decisions and, therefore, to investor protection. A mutual fund, for example, is required to summarize the principal risks of investing in the fund, including the risks to which the fund’s portfolio as a whole is subject and the circumstances reasonably likely to affect adversely the fund’s net asset value, yield, and total return, in both its summary prospectus and statutory prospectus.
The guidance is intended to address another important aspect of fund risk disclosure, namely, the changes in a fund’s susceptibility to risk that may result from changes in market conditions and the need for funds to review and assess risk disclosures in light of changing market conditions. Degree of risk is dynamic in nature rather than static; it changes in response to market conditions, and different risks may be heightened or lessened at different points in time. As a result, a fund may determine that risk disclosure that may have been adequate at one time may need to be reconsidered in light of new or changed market conditions.
If a fund determines that its risk disclosure is not adequate, the SEC believes that the fund should consider the appropriate manner of communicating changed risks to existing and potential investors, for example, in the prospectus, shareholder reports, fund website, and/or marketing materials.