Clarification From OSC on Index Funds

By Andrew Rickard | July 10 2015 10:46AM

The Ontario Securities Commission (OSC) says that in order to use the term "index" in its name, there must be an absence of discretion and transparency in the tracking fund.

In a staff notice published on July 9, the OSC noted that its staff members have seen an increasing number of prospectus filings by funds that purport to be index tracking funds. The OSC says that funds should meet the following criteria if they wish to call themselves index funds: there should be an absence of discretion when choosing investments, and the makeup of the index should be transparent. If funds do not meet these criteria, the OSC will require the fund to remove references to the purported index from the fund's name and investment objectives.

If a fund is tracking the performance of an index, the OSC’s view is that there should not be any material discretion on the part of the index provider or any other party involved in the administration of the index. "This means that the index should use objective and verifiable data as inputs, and the methodology should specify the rules by which the material aspects of the index, such as index value, weighting and constituents, are determined given such inputs," reads the notice.

In terms of transparency, the OSC says that a fund’s methodology or the constituents of the index should be both available to the public and updated as the index is rebalanced or reconstituted. The index and the key factors used in determining its components should also be described in the prospectus, and it should disclose how the fund replicates the index's performance (e.g., by direct investment in the constituents of the index, by stratified sampling, or by synthetic exposure through a derivative).

"In instances where a fund manager does not wish to disclose the Methodology or the constituents of the index, Staff have taken the view that the purported index is a proprietary quantitative model and, while the fund may employ that model as an investment strategy, it is generally inappropriate for the fund to market itself as an Index Tracking Fund," concludes the OSC. "Accordingly, we have asked that such funds remove any reference to "index" from their names and investment objectives."