April 3, 1995
TO: CLOSED-END FUND COMMITTEE No. 14-95
UNIT INVESTMENT TRUST COMMITTEE No. 38-95
RE: SEC CONCEPT RELEASE ON IMPROVING MUTUAL FUND RISK
DISCLOSURE
______________________________________________________________________________
The Securities and Exchange Commission has issued a concept release requesting comment on
how to improve risk disclosure for investment companies, including ways to increase the comparability
of disclosure about fundsG risk levels through quantitative measures or other means. In addition, the
SEC has issued a summary of the release requesting comment from individual investors on ways to
improve the descriptions of mutual fund risks. A copy of the CommissionGs concept release is attached,
which includes as an appendix a copy of the investor release.
Comments are due on the concept release by July 7, 1995. We intend to schedule a meeting
shortly to discuss the issues raised in the release.
The significant aspects of the SECGs release are summarized below.
1. The Goals of Risk Disclosure
The SEC has solicited comment on a variety of issues dealing with the fundamental question of
what “risks” should be disclosed to investors. For instance, comment is requested on the extent to
which “investors [are] concerned with the likelihood that they will lose principal, that their return will
not exceed a specified benchmark (such as the Standard & PoorGs 500), or with the variability of their
returns (or the volatility of the value of their investment) over time.” Comment is also solicited on the
nature of risk comparisons that are useful to investors (e.g., whether risk disclosure should facilitate
comparison between funds and other investment products, among all types of funds, among particular
fund types or only among funds with similar investment objectives and policies). In addition, comment
is requested on whether improved disclosure of risks is equally important for all type of funds (e.g.,
equity, fixed-income, asset allocation funds) and the degree of detail regarding fund risk that should be
communicated to investors.
2. Narrative and Non-Narrative Risk Disclosure Options
Comment is solicited generally on the relative merits and usefulness of various formats for
investment company risk disclosure, including narrative disclosure, quantitative measures, graphs, tables
and other pictorial representations. In addition, comment is requested on a number of specific issues
regarding the use of these various approaches, which are summarized below.
a. Narrative Disclosure Options - The Commission requests comment on the usefulness to
investors of the narrative risk disclosure currently found in prospectuses and on ways of improving that
disclosure. For instance, comment is requested on whether prospectus disclosure should focus on the
broad investment strategies of a fund rather than the particular investments used to implement the
strategy.
b. Quantitative Measures of Risk - The Commission has solicited comment on a number of
different quantitative risk measures. Specifically, comment is requested on measures of “total risk,”
which, as described in the release, “quantify the total variability of a portfolioGs returns around, or below,
its average return.” These measures include standard deviation of total return and semi-variance, which
measures the variability of returns below the average return.
The Commission also has solicited comment on the usefulness of market risk measures, such as
beta, duration and various risk-adjusted measures of performance (i.e., Sharpe Ratio, Treynor Ratio and
JensenGs Alpha), which are described in the release. I addition, separate and apart from durationGs
potential use as a quantitative risk measure, comment is solicited on whether a fundGs name or
investment objective that refers to the maturity of its portfolio, such as “short-term,” should be required
to be consistent with the duration of its portfolio.
c. General Issues Concerning Quantitative Measures - The Commission requests input on a
number of general issues relating to quantitative risk measures, including (1) their potential benefits and
associated costs and burdens, (2) whether quantitative risk measures currently used by investment
companies for internal purposes could be adapted for disclosure purposes, (3) the difficulties that
investors would face in properly interpreting various quantitative risk measures, (4) issues dealing with
the computation of quantitative risk measures, (5) whether, and how, disclosure of risk measures might
influence portfolio management (e.g., could they cause a fund manager to adopt more conservative
investment strategies?), (6) the usefulness of SEC-required disclosure in light of the availability of
quantitative risk information from third party providers and (7) whether the SEC should take steps to
facilitate the dissemination of fund risk information by the financial press and other parties (e.g., by
requiring more frequent or more detailed descriptions of fund portfolio holdings).
3. Self-Assessment of Risk
Another alternative on which the Commission seeks comment is self-assessment by funds of
their aggregate risk level (e.g., a description of where the fund fits on a risk scale from low to high).
Comment is requested on whether the SEC should create a standard scale for these purposes and, if so,
what that scale should be.
4. Risk Management Procedures
The Commission has solicited comment on whether disclosure of fund risk management
procedures should be required. For example, should funds describe the “stress-testing” they do to
determine how the portfolio will behave in various market conditions?
5. Liability Issues
Comments are requested on the appropriate scope of, and limits on, the liability of funds,
investment advisers, and others for various risk disclosures.
* * *
Amy B.R. Lancellotta
Associate Counsel
Attachment