SEC Plan to Limit Fund-of-Fund Redemptions Gets Heat From Fund Industry
The planned restrictions "could harm funds of funds and their shareholders — including target-date funds," ICI's Stevens said.
Redemption limits in the Securities and Exchange Commission’s proposed rule governing funds of funds could hurt investors saving for retirement, specifically those invested in target-date funds, members of the fund industry are warning the agency.
“Our greatest concern focuses on the proposed redemption restrictions that would prevent fund managers from acting in the best interest of investors and could result in financial harm to shareholders, if included in the final rule,” Paul Schott Stevens, president and CEO of the Investment Company Institute, a trade group, told the SEC in an April 30 comment letter.
Jonathan de St Paer, CEO of Charles Schwab Investment Management, echoed Stevens’ concerns in his Thursday comment letter, stating that Schwab’s “most significant concern is that the redemption limits in the proposed rule would undermine the goals of the rule itself and are not in the best interest of either funds or individual investors.”
The proposal, which was out for comment until Thursday, would restrict funds of funds that invest more than 3% in another fund’s outstanding shares from redeeming more than 3% of the fund’s total outstanding shares in any 30-day period.
“These restrictions could harm funds of funds and their shareholders — including target date funds (TDFs), which are commonly structured as funds of funds and have grown in popularity among retirement savers,” Stevens said.
For example, Stevens said, “if a fund is underperforming, it may not make sense for a TDF to hold that fund. The redemption limits, however, could hinder the TDF from quickly replacing that underlying fund with a more appropriate one. This would prevent the fund manager from acting in investors’ best interests and could cause, and exacerbate, financial harm to savers.”
The restrictions, Stevens wrote, “would put funds of funds and their shareholders at a severe disadvantage compared to other investors.”
For example, he said, “a TDF would be restricted from selling shares of an underperforming fund while other investors in that fund would be able to redeem their shares.”
The proposed rule would “prohibit an acquiring fund that acquires more than 3% of an acquired fund’s outstanding shares (i.e., the statutory limit) from redeeming or submitting for redemption, or tendering for repurchase, more than 3% of an acquired fund’s total outstanding shares in any 30-day period.”
While Schwab Investment Management “understands and supports the SEC’s goal of ensuring that an acquiring fund cannot exercise undue control or influence over an acquired fund, the redemption limit could constrain the fund’s advisor from meeting its fiduciary duty in effecting redemptions from the fund of funds, impairing its ability to manage the fund in accordance with its investment and asset allocation strategies,” de St Paer wrote.
The commission, de St Paer said, “should reconsider the proposed redemption limit for a variety of reasons,” adding that the 3% redemption limit “appears to be an arbitrary” designation.
In the fund of funds world, de St Paer said, “it is not unusual for an acquiring fund to own more than 3% of the total outstanding shares of an acquired fund. The Commission’s own data shows that 809 out of 4,342 acquiring funds, or 18.6%, held more than 3% of an acquired fund’s total outstanding shares in a June 2018 analysis.”
Schwab recommended alternatives to the 3% limit, including discretionary redemption limits, in which the SEC could allow the fund company to determine the redemption limit that is appropriate for each fund, with approval from the fund’s Board of Trustees. Another option: requiring “pre-notification of large trades when a fund of funds trades greater than a certain percentage (such as 5%) of the acquired fund.”