The Securities and Exchange Commission adopted a new rule today designed to make it faster and easier for mutual funds to invest in other mutual funds—a practice that grew to $2.5 trillion in 2019.
The SEC approved the rule to allow fund managers to allocate fund of fund investments without seeking individualized exemptive orders for the first time, SEC Chairman Jay Clayton said in a statement. These assets account for some 40% of all fund investments in 2019, SEC staff estimated.
“Main Street investors have increasingly used mutual funds, exchange-traded funds (ETFs) and other types of funds to access our markets and invest for their future,” Clayton said. “To achieve asset allocation, diversification and other objectives, many funds have also invested in other funds. Today’s action will enhance and modernize the regulatory framework for these arrangements.”
The framework the agency adopted “will provide flexibility to fund managers to allocate and structure investments efficiently, without the costs and delays of seeking individualized exemptive orders, as long as the arrangements satisfy a number of conditions designed to enhance investor protection,” Clayton added.
The new rule will also pave the way for more broker-dealers and registered investment advisors to build out fund of fund investment programs for retail investors to use “as a convenient way to allocate and diversify their investments through a single, professionally managed portfolio. For example, a fund of funds may provide an investor with the same benefits as separate direct investments in several underlying funds, without the increased monitoring and recordkeeping that could accompany investments in each underlying fund,” the agency said.
Open-end funds, unit investment trusts, closed-end funds, exchange-traded funds and exchange-traded managed funds will all be able to rely on the new rule (12d1-4) to acquire and market funds.
To protect investors, the SEC also included a number of controls and limits on funds and the fees they charge. For instance, to address concerns that an acquiring fund could exert undue influence over an acquired fund or charge duplicative fees and expenses, the rule will require to evaluate fee structures and record their findings first before making the investment.
In addition, the rule will require funds that do not share the same investment adviser to enter into a fund of funds investment agreement memorializing the terms of the arrangement. This and the evaluation and finding requirements replace a proposed requirement that would have prohibited an acquiring fund that acquires more than 3% of an acquired fund’s outstanding shares from redeeming more than 3% of the acquired fund’s total outstanding shares in any 30-day period, the SEC said.
To limit funds’ ability to use fund of funds arrangements to create overly complex structures, the new rule will prohibit funds from creating three-tier fund of funds structures, except in certain circumstances. The proposal also creates an exception that permits an acquired fund to invest up to 10% of its total assets in other funds (including private funds) without restriction, the agency said.