On September 20, 2023, the U.S. Securities and Exchange Commission (SEC) adopted amendments to Rule 35d‑1 (the “Names Rule”) under the Investment Company Act of 1940 (the “1940 Act”). The main objective of the amendments is to “modernize and enhance” Rule 35d-1, make sure that “a fund’s portfolio holdings align with a fund’s name,” and impose additional disclosure, reporting, and record-keeping requirements.
Expansion of the 80% investment policy requirement
Under Rule 35d-1 as adopted in 2001, if a fund name suggests particular investments or industries, the fund must adopt a policy to invest at least 80% of its assets in investments suggested by the fund’s name (80% rule).
The recent Names Rule amendments expand the requirement with categories such as “particular countries or geographic regions” or “investments that have, or whose issuers have, particular characteristics."
Particular characteristics and plain English
The Commission did not define the term “particular characteristics,” but it should be understood as any feature, quality, or attribute of the issuers or investments. For example, a name with terms such as growth or value, or terms indicating the fund’s investment decisions incorporate one or more environmental, social, or governance factors.
The amendments require that any terms in a fund’s name that suggest an investment focus must be consistent with the plain English meaning or the established industry use.
That said, there are exceptions. Terms that do not communicate a particular investment focus, suggest a portfolio-wide result (absolute return, balanced), describe a portfolio’s general characteristics (short duration), or reference an investment technique/portfolio construction (long-short, hedged, global) would be exempted from the 80% investment policy requirement.
Temporary departures from an 80% investment policy
The Names Rule requirement for a fund to invest in accordance with its 80% investment policy “under normal circumstances” applies at the time a fund invests its assets. The amendments include a new requirement for a fund to review its portfolio holdings in the 80% basket at least on a quarterly basis. If the fund departs from its 80% policy, it must be back in compliance within 90 days.
Derivatives and exclusions/special cases
Derivatives may be included in the calculation of the 80% investment policy threshold. The amendments, like rule 18f-4, require a fund to:
Use derivatives’ notional amounts instead of market values
Apply a 10-year equivalent for interest rate derivatives
Use delta-adjustment for options
Value physical short positions with the value of the asset sold short
For Names Rule purposes, funds may exclude from their assets certain derivatives transactions (used for currency hedges and notional less than 110% hedged value) and deduct cash/cash equivalents/US Treasuries with remaining maturities less than one year. Closed-out positions should not be closed with the same counterparty for a fund to exclude them from its assets.
Disclosure, Notice, Form N-Port
The amendments require the fund to define the terms it uses in its name and disclose the criteria for determining investments that fall within the definitions. The fund’s prospectus is required to include this disclosure.
The amendments keep the existing Names Rule requirement that sixty (60) days’ notice must be provided to fund shareholders of any change in the fund’s 80% investment policy—unless the 80% investment policy is a fundamental policy.
The amendments include new Names Rule reporting items for Form N-Port. Each fund should report:
Whether each investment in the fund’s portfolio is in the fund’s 80% basket, for purposes of measuring compliance with its 80% policy
The value of the fund’s 80% basket, as a percentage of the value of the fund’s assets
Definitions of terms in the fund’s name
Transition Period
Fund groups with net assets of $1 billion or more have 24 months to comply with the amendments following the effective date, and fund groups with net assets of less than $1 billion have 30 months to comply.
The SEC estimates the percentage of funds required to adopt the 80% policy rule will increase to 76% from 60% because of the amendments to the Names rule.
Because the implementation and enforcement may be challenging, in-scope firms may want to consider taking the following steps:
Review the current portfolio holdings and their alignment with the funds’ names
Set up a framework to tag the individual securities and indicate whether they are part of the 80% basket
Implement changes to current reporting tools, including Form N-Port engines to adopt the new disclosure requirements
Set up an operational framework for internal control and communication, since any changes to fund names, amendments to a fund’s registration statement, or long deviation from the 80% rule require board notification/approval.
The FactSet Pet Care Index is a thematic equity benchmark designed to track the performance of companies that stand to benefit from interest in or resources spent on pet ownership. The index is a reference index for thematic exchange-traded/index funds, financial products that fall under the amended Names Rule. Based on the 80% investment policy, 80% of the portfolio assets should be invested in securities with exposure to pet ownership/pet services.
FactSet’s Portfolio Analysis application can group the portfolio assets by RBICS with Revenue-Industry classification, which aggregates companies’ revenue exposures to each RBICS Industry (by aligning segment revenues to the granular RBICS taxonomy).
Figure 1 shows that Pet and Pet Supply Retail, Veterinary Products, Meat and Seafood Production, Veterinary Services, Personal Insurance, and Pet Supplies Manufacturing RBICS Revenue contribute approximately 83% of a portfolio holdings’ revenue exposure to the Pet Ownership theme and therefore meet the 80% investment requirement.
Figure 1: FactSet Pet Care Index and RBICS Industry with Revenue
As summarized above, the amendments present significant changes that impact existing and new funds. Given the scope of work that might be required, investment firms and financial intermediaries may want to start their compliance tests, evaluate the fund’s name, set up the operational framework for compliance, and implement the new reporting and recordkeeping framework.
This blog post is for informational purposes only. The information contained in this blog post is not legal, tax, or investment advice. FactSet does not endorse or recommend any investments and assumes no liability for any consequence relating directly or indirectly to any action or inaction taken based on the information contained in this article.