The Ontario Securities Commission recently released OSC Staff Notice 81-728 (the Notice), which provides guidance on investment funds that include the word “index” in their names and whose investment objectives are to replicate the performance of an index (Index Tracking Funds). Two factors are relevant when determining if it is appropriate for a fund to market itself as an Index Tracking Fund: (i) absence of discretion, and (ii) transparency.
Absence of discretion
To be considered an Index Tracking Fund by the OSC, the methodology governing the index whose performance is being replicated (the Methodology) should generally not allow for the application of material discretion on the part of the index provider or any other party involved in administering the index. If material discretion is permitted when administering the index, the OSC will (i) generally view the Methodology as being more akin to an active investment strategy, and (ii) take the position that it is misleading to investors to refer to such a strategy as an “index” in the fund's name and investment objectives, or to market the fund in a way that suggests it is an Index Tracking Fund.
The index whose performance an Index Tracking Fund seeks to replicate should be transparent, with transparency being achieved either by making the Methodology or the constituents of the index available to the public or by posting the Methodology or list of constituents on the website of the Index Tracking Fund or the index provider.
The OSC expects that the prospectus of an Index Tracking Fund sufficiently describes the applicable index and discloses how the Index Tracking Fund replicates the index (e.g., by direct investment in the constituents of the index, by stratified sampling, or by synthetic exposure through a derivative).
Index mutual funds / index participation units
Note that an index may satisfy the conditions described in the Notice without necessarily satisfying the definitions of “index mutual fund” or “index participation unit” in National Instrument 81-102 - Investment Funds (NI 81-102). In such a situation, even though the fund may include “index” in its name and investment objectives, the exemptions provided to index mutual funds or index participation units under NI 81-102 may not be relied on.