Fund names that insinuate a level of underlying risk will have to closely match regulator-approved volatility ranges under revised Financial Markets Authority (FMA) proposals released earlier this month.
In a discussion document released on July 6, the FMA called for further industry feedback on its updated ‘risk indicator’ design first issued last December.
The FMA says while the risk indicator guidelines, modeled on a 2010 European-designed system, are essentially unchanged from the December version, it has added three new sections to the proposal document: ‘Describing the volatility of managed funds’; ‘Updating a PDS for a change in risk category’; and, ‘Naming conventions for funds’.
Under the new proposals, funds with labels such as ‘defensive’ or ‘aggressive’, for example, would have to conform to tight volatility ranges.
“… managers who use names that suggest fund characteristics are not permitted to call funds by a name that is misleading, for example, if it misrepresents the types of products that the fund may invest in,” the FMA guidance document says.
For instance, products labeled ‘defensive’ could have no more than 9.9 per cent of the fund value in growth assets while ‘aggressive’ “would usually be expected to hold 90% to 100% of their value in growth assets”, the FMA says.
The new discussion document also prescribes words fund managers would be allowed to use to describe the risk attributes of their products, which will be assigned a numerical value from 1 to 7 in the FMA’s ‘risk indicator’ system.
“The regulations do not require managers to describe the risk ranking of their fund in words. In our view, different descriptions for the same risk category may be confusing and misleading for investors. Different descriptions will also interfere with the comparability of risk categories between funds,” the FMA document says.
“To address these concerns, we have developed a standardised description of risk categories…
“If a manager chooses to use words to describe a fund’s volatility, they should use this consistent terminology in their ratings description to facilitate risk comparisons between funds, and to ensure investors are not misled.”
Like the Committee of European Securities Regulators (CESR) fund risk indicator standards on which it is based, the FMA-designed ‘risk indicator’ is intended to give investors a quick snapshot of product risk, as measured by standard deviation volatility.
“The regulations require the risk indicator to be based on annualised standard deviations calculated using the change in returns from week to week or (if not available) from month to month over five years,” the FMA document says.
Under the proposals, most fund managers would have to adopt standardised volatility measures with alternative methods possible for absolute return funds, total return funds, life-cycle funds and structured funds based on CESR guidelines.
“In our view, the CESR’s methodologies are appropriate alternatives for calculating risk indicators for funds in the identified categories,” the FMA says. “We expect managers of these funds to use the CESR Guidelines when they need alternative methods to calculate a risk indicator of the fund.”
Submissions close on August 14 this year with the ‘risk indicator’ regime, included in the Financial Markets Conduct Act, scheduled to come into force at the end of this year.