SEC streamlines process for creation of fund of funds

Investment funds that buy shares in other funds will be able to do so with fewer regulatory hurdles under a rule the Securities and Exchange Commission adopted Wednesday.

The agency would allow a so-called fund of funds to acquire shares of another fund in excess of current limits without requiring individual approval as long as the fund meets certain conditions. A fund of funds is a pooled investment vehicle consisting of other underlying funds that diversify the acquiring fund.

The new rule applies to open-end funds, unit investment trusts, closed-end funds (including business development companies), exchange-traded funds and exchange-traded managed funds. It was approved unanimously by the five SEC members in a nonpublic vote.  

The regulation includes safeguards to prohibit an acquiring fund from controlling or exerting an undue influence over an acquired fund. It prevents the charging of duplicative fees and limits overly complex structures. It does not allow funds comprising a fund of funds to share the same investment adviser.

“To achieve asset allocation, diversification and other objectives, many funds have invested in other funds,” SEC Chairman Jay Clayton said in a statement. “Today’s action will enhance and modernize the regulatory framework for these arrangements … [and] 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.”

The rule will become effective 60 days after its publication in the Federal Register. To ease the transition to the new framework, the compliance date and the rescission of the current rule and exemptive orders will not occur until more than a year later.

The agency and the industry will need that extra time to acclimate, said SEC Commissioner Hester Peirce.

“Transitioning from an exemptive order framework for funds-of-funds won’t be easy, but a consistent, workable regulatory approach is important,” Peirce wrote in a tweet. “For less common arrangements, the exemptive process is still available.

The Investment Company Institute, which represents the mutual fund industry, supports the new rule on first glance.

“The SEC’s final fund of funds rule helps streamline the regulatory framework governing funds of funds,” ICI general counsel Susan Olson said in a statement. “Though ICI is still analyzing the SEC’s release, we are pleased that the Commission removed the proposed redemption restrictions that would prevent fund managers from acting in the best interest of investors.”

The fund of funds rule was initially proposed in December 2018. The agency took public comments through last March.

Approximately 40% of all registered funds hold an investment in at least one other fund, according to the SEC. Assets in such arrangements totaled $2.54 trillion last year.