The Financial Markets Authority (FMA) plans to issue an interim updated index get-out clause for licensed managed funds ahead of a more “fulsome” investigation into the bespoke benchmark rules.
In a new consultation the FMA flags a one-year extension of the current index exemption available to certain managed funds pending the outcome of a detailed review of NZ industry benchmarking practices.
Under the existing five-year exemption (due to expire this July) funds with exposure to alternative assets can skip the duty to measure performance against standard market benchmarks or use other metrics such as peer group or composite indices
The regulator will decide by September 2023 whether to roll over the exemption for a further five-year term from July next year or scrap the indexing relief.
“If we decide that these exemptions are no longer warranted, or that substantive amendments are required, we will provide notice of this and, if needed, provide a transitional period to give entities that rely on the exemptions an opportunity to make any necessary changes to business systems and processes,” the FMA consultation says.
But while the regulator is buying some time before committing to another five-year index exemption, the stop-gap measure also introduces a new option for funds investing in ‘single assets’ like bitcoin.
Previously, such single-asset funds have typically declined to provide a benchmark guide for investors – as allowed via the exemption.
“At the time the current notice was issued, the inability to comply with the market index requirement was most acute for managers of funds investing in alternative assets (such as real estate, infrastructure and hedge funds) or funds that followed an alternative investment strategy. The introduction of an alternative peer group index (or composite index) under the current notice was designed to address that problem,” the FMA says.
“However, alternative funds have continued to evolve and innovate. Funds investing in other alternative assets such as cryptocurrencies and commodities appear to be more popular now. These developments support consideration of this proposal to amend the terms of the exemption.”
Funds that invest only partially into alternative assets will also be able to construct composite benchmarks including any single-asset indices.
“A fund made up of both relevant and non-relevant assets which produces a composite index of appropriate market indices and peer group indices could also add a single asset index to its composite index in relation to any single assets it invests in,” the consultation document says. “This would also improve the overall relevance and accuracy of the composite index.”
The FMA has earmarked indices for special attention through its ‘value-for-money’ campaign, pressuring managers to adopt market-linked benchmarks where possible.
In many cases, though, managers argue off-the-shelf benchmarks may not be appropriate for particular funds – a mismatch the index exemption addresses.
While the exemption resolves the impasse between law and industry practice, the ability of local fund managers to rely on handcrafted composite benchmarks has come under attack this year in a recent Russell Investments NZ paper.
Russell suggests all single-asset funds should be measured against “independently calculated and representative indices” with a reference portfolio approach (of risk-weighted passive investments) would suffice for most diversified strategies.
The investment consultant also makes the case for all KiwiSaver diversified funds to follow a similar reference portfolio model.
In a final point, the FMA also reiterates that the exemption does not allow fund managers (only licensed ones, of course) to use “absolute or total return indices” as formal performance metrics.
“These types of indices typically do not provide contextual information about the performance of the assets or markets the fund invests in; an absolute return benchmark does not reflect movements in the markets or assets the fund invests in,” the consultation says. “Absolute return indices also have a discretionary element set by the manager and are therefore not independent.”
Submissions close by end-of-business on March 30.