January 28, 2006

Information overload
While good, 81-106 requires too much

Tom Stanley's recent decision to wind down his top performing Resolute Growth Fund was made, he said, as a result of the burden and expense of increasing regulation. Specifically, he cites the disclosure required by National Instrument 81-106 (Continuous Disclosure) as a key motivator to abandon the traditional mutual fund structure. While we should shed no tears for Mr. Stanley, I don't disagree with his decision.

Stanley's beef

The specific part of 81-106 with which Mr. Stanley took exception is that requiring all mutual funds to disclose, each quarter, its 25 largest positions. Stanley's Resolute Growth only tends to hold about twenty stocks - all of them rather illiquid.

To be honest, I'm not sure there's much value in that added requirement. As an analyst, I'm always in favour of more detail as opposed to less. But, I can't say that having the top 25 holdings is going to provide me with greater insight. And in the case of Stanley (and perhaps other funds in similar positions), it will drive good funds out of the reach of many investors.

I can think of things I'd rather have than the top 25 each quarter. As it is, most funds already disclose their top 10 or 15 holdings each month to firms like Fundata, Globefund, and Morningstar Canada. It's not required but these are key data providers that many look to when making investment decisions.

I can think of a couple of things I'd rather have instead of this quarterly disclosure.

More detailed transactions

Funds are already required to file statements of portfolio transactions every six months. Some fund companies provide more details than others but I'd love more information and more standardization for these reports.

For instance, TD Asset Management provides the best detail. TD provides buy and sell transactions by each trade per day. As an example, you'll see that a fund bought 10,000 shares of a particular stock on June 20. Then, they might show that more shares of the same stock were bought again later that day at a different price. It's the most detailed breakdown I've seen.

What most others do is simply provide totals for the reporting period. Instead of the nice breakdown provided by TD, most simply show that a total of 500,000 shares of XYZ Corp. were purchased - no date and no indication of how long it took to accumulate the shares. And no way to see how far apart buy and sell transactions occurred in the same stock.

Sometimes the most revealing of details found in the Statement of Portfolio Transactions are the short term trades that are so quick they don't show up on the portfolio statements at a point in time.

Ascertaining the ascertainable

NI 81-106 made my job a little easier in a couple of other ways. For one, it requires funds to disclose what is called a "Trading Expense Ratio" - which is the total of all explicit trading costs as a percentage of average net assets (just like the MER). Adding the two together gives a more accurate 'all-in' expense ratio for funds. The information was always available but now it's much more user-friendly. But this was not a 'must have' for me since I could always figure it out. Most of those investors keen enough to want this information usually know where to find the details.

More significantly, I look forward to see added disclosures around soft dollars, which is the practice of paying higher brokerage fees to receive services in addition to simple trade execution. This is how many portfolio managers pay for street research. Since many managers boast of how little street research they rely on; breaking out the soft dollars out of total brokerage fees will be revealing. But they'll only be required to do so to the extent that the soft dollar portion is "ascertainable". That last part worries me but I'm still anxious to see how that will look.

Shift focus

Mutual funds are, by and large, heavily regulated investments that offer quite good disclosure. If the brain-trust at Canada's securities regulators wants more disclosure, their focus should be on things like alternative investments like hedge funds not on added disclosure from an already heavily regulated class of investment. Not that more transparency isn't important - it is.

But the muddier class of alternative investments has lots of catching up to do when it comes to transparency. And when increasingly complex investments are penetrating distribution channels aimed at retail investors, this is where the focus should be - instead of scaring some of our best boutique fund companies away from the retail investors that need them most.