The Securities and Exchange Commission has granted no-action relief to allow index funds to become non-diversified as a result of market changes to the underlying index components.
Without the relief, according to Cipperman Compliance Services, “an index fund that tracks a third-party index would have to obtain shareholder approval to change its status from diversified to non-diversified when certain underlying component securities increased in value such that they would make up more than 5% of the portfolio.”
Cipperman stated that the non-diversified issue “has dogged large index funds and ETFs for the last couple of years as the FAANG securities have increased in market value as compared to other index components.”
FAANG refers to the market’s five most popular and best-performing tech stocks — Facebook, Apple, Amazon, Netflix and Alphabet’s Google.
The relief would require prospectus disclosure that the fund could become non-diversified during these periods, Cipperman said, and the fund would still be constrained by the diversification requirements of the tax code and the applicable exchange on which it is traded.