Comment Letter on IOSCO Performance Presentation Standards, August 2003

General Secretariat
International Organization of Securities Commissioners (IOSCO)
a/s Mr. Terry Hart
Plaza de Carlos Triás Bertrán, 7
Planta 3a
28020 Madrid
España

The Investment Company Institute¹ appreciates the opportunity to comment on IOSCO's Report regarding the advertising of performance information by Collective Investment Schemes ("CIS"). The Report presents suggested best practice standards for CIS performance advertisements based upon the Technical Standing Committee on Investment Management's ("SC5") study of performance presentation standards ("PPS"). The Institute, in general, strongly supports the suggested best practice standards and believes that IOSCO should continue in its efforts to encourage jurisdictions to consider the comprehensiveness and effectiveness of their PPS in order to enhance investor protection.

The Report sets forth suggested best practice standards related to several matters, including: standardized formulas, fees and expenses, standardized time periods, currentness of performance information, use of performance benchmarks, and use of disclaimers. In addition, the Report recommends that CIS consider including data in performance advertisements to demonstrate the volatility of performance over time. We are pleased that many of the suggested best practice standards are consistent with our views regarding the essential elements of an effective mutual fund performance reporting system.² In summary, our comments are as follows:

We support the suggested best practice standards regarding standardized formulas, disclosure of fees and expenses, standardized time periods, currentness of performance information and use of disclaimers.
We request IOSCO to encourage all member jurisdictions to adopt mandatory regulations to govern performance advertising. Mandatory rules ensure that all advertisements containing performance are subject to the same requirements with respect to computation, currentness, and disclosure.
We oppose the suggested best practice standard relating to the use of performance benchmarks. We continue to believe that requiring funds to compare their performance to an index is inappropriate and potentially misleading.
We disagree with the suggestion in the Report that a CIS should consider including additional data, such as standard deviation data in performance advertisements to demonstrate the volatility of its performance. We believe that funds should not be required, or encouraged, to report a single, standardized, numerical measurement of risk in their disclosure documents.
We urge IOSCO to address the use of performance rankings in its best practice standards. Making rankings subject to best practice standards should help to ensure that they are presented in a complete, consistent, and non-misleading manner.
We request IOSCO to omit the best practice standard that states that CIS should provide "additional relevant information" relating to performance upon the request of any investor. The potential costs associated with such an open-ended requirement outweigh any possible benefits.

I. General Comments
As stated above, the Institute supports many of the suggested best practice standards. For example, we support: (i) the standard regarding the use of standardized performance information,³ including requiring the standardized performance figures to reflect the deduction of all fees and expenses directly paid by the typical CIS investor⁴ and fees indirectly paid by each CIS shareholder; (ii) permitting non-standardized performance information to appear in an advertisement containing the standardized performance information; (iii) the standard regarding the use of standardized time periods;⁵ and (iv) the standard regarding disclosure in advertisements. We believe that these best practice standards should help to promote comparability, permit CIS to compete in a fair and equitable manner, and assist investors in understanding that advertised performance figures do not represent a promised return.

The Report encourages jurisdictions with voluntary PPS to evaluate and consider their effectiveness. Because we continue to believe that performance presentation standards should be mandatory, we request that IOSCO go further and encourage these jurisdictions to adopt mandatory regulations to govern performance advertising. Mandatory rules ensure that all advertisements containing performance are subject to the same requirements with respect to computation, currentness, and disclosure. This kind of system permits investors to compare fairly uniform performance information among funds.

II. Specific Comments
A. Use of Performance Benchmarks
The Report states that CIS performance information should be accompanied by a relevant performance benchmark(s). We strongly urge IOSCO to eliminate this as a suggested best practice from the final report. We believe that funds should not be required to compare their performance to an index because such a comparison is inappropriate and potentially misleading. Such a comparison, among other things, ignores that (a) for many funds, there is no appropriate index; (b) index performance is shown on a cost-free basis while funds may be required to deduct all expenses from performance (which we believe is appropriate); and (c) funds are required, as a practical matter, to maintain a portion of their portfolio in liquid assets to meet redemptions, which adversely affects performance in a rising market and which enhances performance in a falling market. We further believe that index comparisons are especially inappropriate in fund advertisements, given the limited space in such communications.

B. Use of Volatility Information
The Report states that CIS should consider including data in advertisements to demonstrate the volatility of performance over time, such as a bar chart showing changes in performance from year to year, or standard deviation data. While the Report does not designate the practice of providing volatility information as a best practice, per se, the Report does seem to endorse this type of disclosure in CIS advertisements. We strongly disagree with encouraging the use of standard deviation data in CIS advertisements, as explained more fully below.

Requiring funds to report a single, standardized, numerical measurement of risk is fundamentally flawed because it rests upon the erroneous assumption that there is a single, optimal measure of investment risk. It ignores the fact that risk is a multifaceted concept, necessarily having different meanings for different investors. (For example, measures based on short-term volatility are not especially meaningful for long-term investors.) Such measures also pose the danger that investors-neither understanding the limitations of such a measure nor accurately assessing its relevance and appropriateness to their particular circumstances and investment objectives-nonetheless will rely upon it to their detriment. We believe that there are better ways to communicate information about the risk of a fund to investors, such as narrative disclosures in fund prospectuses and disclosure of year-by-year performance information in fund prospectuses (which can highlight volatility in returns).

C. Rankings
The Report states that a CIS may wish to advertise rankings that demonstrate the performance of the CIS relative to other CIS and notes that the best practice standards do not address the use of rankings in CIS advertisements. We urge IOSCO to reconsider this approach. We believe that the use of rankings in advertisements should be subject to best practice standards to ensure that they are presented in a consistent, complete, and non-misleading manner. For example, such standards should require general information about the rankings, and rankings for sufficiently different lengths of time in order to show a fund's rankings over different market cycles (e.g., a short-term, medium-term, and long-term period).

D. Other Relevant Information
The Report includes as a suggested best practice standard the following: "[a] CIS should provide additional relevant information relating to its performance upon the request of any investor."⁶ We request IOSCO to eliminate this suggested best practice. It would be potentially very burdensome for a CIS to comply with such an open-ended standard, which does not appear to be limited by any notion of reasonableness. The suggested standard appears to be engendered by a concern that investors will misunderstand performance information. We believe that this concern is adequately addressed by the standard requiring advertisements to be accompanied by all explanations, qualifications, and other statements that are necessary to prevent such information from misleading investors.⁷

E. Exclusion of Prior Performance
The notes that accompany the best practices standards state that if a CIS changes its investment objective, the performance prior to the change should not be excluded. We agree that in most instances a CIS that changes its investment objective should continue to include the performance it experienced prior to the change; otherwise, a fund with poor performance might be encouraged to change its operations simply to eliminate unfavorable data from its historical performance record, to the possible detriment of its shareholders. Despite this, we request that IOSCO acknowledge that a CIS should be able to omit past performance data in those instances where there are significant types of changes in operations (e.g., an unmanaged investment entity with a fixed portfolio becoming a management investment company).

The notes also state that if two funds merge, the performance of the surviving fund should be presented for periods before and after the merger. We believe that this approach should be refined to suggest that in determining whether to use the surviving or non-surviving fund's performance, an analysis of both funds should be made to determine which predecessor fund the surviving fund most closely resembles.

The Institute appreciates the opportunity to provide these comments on the Report. If you have any questions concerning these comments or would like additional information, please contact the undersigned at 202-326-5826 or Dorothy M. Donohue at 202-218-3563.

cc: Douglas Scheidt, Chief Counsel
Sara P. Crovitz, Senior Counsel
Division of Investment Management
U.S. Securities and Exchange Commission

ENDNOTES

¹ The Investment Company Institute is the national association of the U.S. investment company industry. Its membership includes 8,678 open-end investment companies ("mutual funds"), 555 closed-end investment companies, 106 exchange-traded funds, and six sponsors of unit investment trusts. Its mutual fund members have assets of about $6.697 trillion, accounting for approximately 95 percent of total industry assets, and 90.2 million individual shareholders.

² We previously provided IOSCO with our views on the required elements of an effective mutual fund performance reporting system. See Letter from Mary S. Podesta, Senior Counsel, Investment Company Institute, to the General Secretariat, IOSCO, dated September 27, 2002 ("Institute 2002 letter").

³ The Report does not suggest a particular type of standardized performance figure. We continue to believe that the basic standardized performance figure for funds other than money market funds should be total return and that funds that advertise yield should do so pursuant to a standardized formula. See Institute 2002 letter.

⁴ The notes to the best practice standards state that in some jurisdictions, sales loads are negotiable and, as a result, there may be no typical sales load paid by investors in a particular CIS. The consequence of this seems to be that CIS with negotiated sales loads would be permitted to advertise standardized return, consistent with IOSCO's best practices, even if the advertised return does not reflect any sales load. This aspect of the suggested best practices is inconsistent with the general approach of requiring standardized return to reflect the sales load paid by the typical investor and should be omitted.

⁵ We agree that requiring that performance be shown for sufficiently different lengths of time provides a picture of fund performance over different market cycles (e.g., a short-term, medium-term, and long-term period). We request, however, that some accommodation be made for new funds that would permit them to advertise performance for periods shorter than one year. The notes that accompany the best practices standards state, in part, that advertisement of CIS performance information for very short-term periods, such as for less than one year, may be atypical and misleading. While we support this general proposition, we request that the notes to the best practices make clear that annualized total return for these funds may be misleading but that it may be appropriate for such a fund to advertise aggregate total return in addition to, or in lieu of, the annualized performance figure.

⁶ See Report at p. 5.

⁷ See, e.g., Report at p.2.