The Ontario Securities Commission (OSC) recently published guidance on investment funds whose investment objectives are to replicate the performance of an index and that include the word “index” in their names (Index Tracking Funds).  In OSC staff’s view, the applicable index should generally (a) not allow for the application of material discretion; and (b) be transparent.  In cases where these conditions are not satisfied, in the course of prospectus reviews, OSC staff will ask that references to the index be removed from the fund’s name and investment objectives to avoid potentially misleading investors.

Absence of Discretion: First, the methodology governing the applicable index (Methodology) must not allow for material discretion in respect of administering the index.  OSC staff’s view is that replicating the performance of an index is a passive investment strategy.  The ability of the index provider or another party to employ material discretion in administering the index results in the Methodology being more like an active investment strategy according to OSC staff.

Transparency of Index: Second, the applicable index must be transparent.  OSC staff suggest that transparency can be achieved by making public key information, such as the Methodology or the constituents of the index, by posting such information to the website of the fund or index provider.  Furthermore, OSC staff expect that the prospectus should sufficiently describe: the index; how the fund replicates the index; the key factors in determining the constituents of the index; the frequency with which the index is rebalanced and reconstituted; and links to the website where the Methodology or index constituents can be found.  OSC staff have taken the view that if a fund manager does not wish to disclose the Methodology or the constituents of the index, the purported index is considered a proprietary quantitative model.

If either condition is not met, OSC staff have taken the view that it is inappropriate and perhaps misleading for the fund to market itself as an Index Tracking Fund.  OSC staff have asked such funds to remove references to “index” from their names and investment objectives in the course of prospectus reviews.

For further information, please consult OSC Staff Notice 81-728 Use of “Index” in Investment Fund Names and Objectives.