Enhanced disclosure requirements recently imposed by regulators are providing more fund information to investors. But some observers question whether the effort will be counterproductive and result in higher costs and lower investment returns.

Among the new information that must now be disclosed by fund companies is more detail on trading expenses of mutual funds sold by prospectus to retail investors.

Fund companies have always been required to report total trading costs and other commissions, but only as a total dollar amount. Starting with their reports for the fiscal year ended June 30, 2005, they must report these trading costs as an annualized percentage of daily net assets — the trading expense ratio.

As stated in the Ontario Securities Commission’s National Instrument 18-106, the TER must be displayed in a table in each mutual fund’s annual report. The table must also include the fund’s net assets, number of units or shares outstanding, management expense ratio and portfolio turnover. The annual report must be issued within 120 days of yearend.

“The OSC formerly required presentation of the dollar value of trading costs, but this information will now be presented in a more clear and useful manner, as a ratio that will be put up beside the regular MER rather than found in the notes to financials, as it was before,” says Eric Pelletier, manager of media relations at the OSC in Toronto.

Because this is the first year that the TER is required, there is no comparable information for previous years, but the table will ultimately contain five years’ worth of information.

The dollar amount spent on trading costs ultimately takes a toll on investor returns. But on its own, a dollar figure doesn’t mean much to investors reading the financial reports unless they can measure these costs as a percentage of assets, as is now required. When investors combine the TER with the MER, they have a clearer picture of the costs of money management.

Aamir Mirza, legal counsel to the Investment Funds Institute of Canada, says the new TER disclosure requirements are a “drill down,” providing more details to investors interested in fees. But, he says, just because the information is there, it doesn’t mean it’s of interest to the majority of fund investors.

“The usefulness of the information depends upon what the investor finds relevant,” he says. “If the individual who reads the annual financial information likes to drill down, it will be relevant. For those who don’t take the document out of the wrapper, it won’t be useful.”

Although the TER information is relatively easy for fund companies to provide, the new disclosure requirements also call for a detailed semi-annual fund performance summary for each fund, plus quarterly disclosure of the top 25 holdings in every fund. Managers must also disclose how they vote the shares they hold in their portfolios in proxy battles and on other shareholder issues. The new standards require more work and, therefore, more expense for fund companies.

Although the role of regulators such as the OSC and the Canadian Securities Administrators is to watch out for investors — and IFIC is “sympathetic” to this aim — there is also a balance required between information and cost, Mirza says. There is also the risk of providing so much information that the investor can’t see the forest for the trees.

“There’s a cost to the extra layers of disclosure, and we know who ultimately bears that cost — the investor,” says Mirza. “The question is whether the cost is worth the value. If you said to the investor: ‘By the way, you are paying a certain amount for this information. Do you still want it?’ would they say, ‘Yes’? The information could be useful for savvy investors, but is there a hue and cry for it?”

Stan Buell, president of the Small Investor Protection Association of Markham, Ont. says that although more disclosure is “motherhood,” more rules and regulations are not necessarily the solution to investor protection from unscrupulous advisors who sell unsuitable products.

“There may be more disclosure in the fund prospectus that satisfies the legal entities, but most investors are not lawyers,” he says. “We need plain language and real examples, and not something so comprehensive and convoluted that the average person won’t read it. A lot of paperwork is done to satisfy the regulators, but there’s also a lot of smart people creating products to circumvent the regulations. More disclosure doesn’t necessarily help the 93-year old widow who has lost her life savings.”

@page_break@Gavin Graham, vice president and director of investments at Toronto-based Guardian Group of Funds Ltd. , says that if disclosure requirements become too onerous and expensive, they can run into the “law of unintended consequences,” such as encouraging investment-management companies to sell funds by the legal process of an offering memorandum instead of the more rigorous prospectus.

For example, Tom Stanley, manager of Resolute Growth Fund, sponsored by Toronto-based Resolute Funds Ltd., has decided to wind up his 12-year-old fund next June rather than disclose his top 25 holdings, which tend to be in small-cap stocks. The prices of his more illiquid holdings can be easily influenced if others attempt to duplicate his portfolio.

The fund, which typically holds less than 20 stocks, has achieved a 30% average annual rate of return since its December 1993 inception. The fund’s average annual compound return of 34.4% for the 10 years ended Feb. 28 is the best among all Canadian mutual funds tracked by Morningstar Canada.

“We’ve been facing ever-increasing regulatory expenses, detrimental disclosure requirements, rising liability risks and increasing red tape,” Stanley wrote in a January letter to unitholders. In June 2005, he opened Resolute Performance Fund, which is sold by offering memorandum and not subject to the same disclosure requirements and investment restrictions as funds sold by prospectus. It is available to investors who can afford the $150,000 minimum investment or who qualify for the more lenient standards that apply to accredited investors who meet provincial requirements for income and investment assets. It’s similar in style to Resolute Growth. IE