How new fund regulations will affect you

A European regulator is forcing providers of exchange-traded funds (ETFs) to be clearer on how their funds work. Paul Amery explains what that means for you.

A battle is raging between regulators and the providers of financial benchmarks indices such as the FTSE 100 over how much information they should disclose to investors. This may sound arcane, but it has a real impact on any investor in exchange-traded funds (ETFs) or other index trackers. I'll explain why shortly, but first, what is the argument about?

ESMA, Europe's securities markets regulator, has decided that if a European retail investment fund (a Ucits') wishes to invest in a financial index, then from next year it will have to make sure that a full explanation of how the index is constructed is available on a public website.

Almost all European ETFs are both Ucits and index-trackers of some sort, so are directly affected. But index providers aren't keen. They fear that the intellectual property' they provide via their indices will be diluted if they have to disclose too much about how those benchmarks work. In turn, their substantial licensing fees could be watered down if ESMA's proposals take root.

Why does this matter to you? Well, compare a traditional fund with an index-tracking ETF. If you invest in an actively managed fund, you hand responsibility for looking after your hard-earned cash to a fund manager, who decides what to buy and sell with your money.

Index trackers, on the other hand, use a formula to deploy their money (which is one reason why they are much cheaper). When the FTSE 100, for example, picks the top 100 British firms and weights them by market size, your money follows suit. This means your ETF's performance relies entirely on the rules used to build the underlying benchmark. So you need to understand what they are.

Now, this might not matter for a simple index like the FTSE 100. But it's very important if you want to invest in one of the many indices that now use quite sophisticated strategies. For example, some indices generate very high turnover (stocks move in and out on a regular basis), and it may be unclear if and how such trading activity has been reflected in past performance figures.

It's fair to say that up until now the levels of disclosure on index-related information on ETF issuers' websites have been poor. So it's good news that ESMA is insisting on more. In the meantime, as always, if you plan to buy an ETF, make sure you understand exactly what it does and how it does it otherwise, leave well alone.

Paul Amery edits www.indexuniverse.eu, the top source of news and analyses on Europe's ETF and index-fund market.

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