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The proposal under chair Gary Gensler would apply to everything from ‘core’ and ‘growth’ funds to those that purport to invest in ‘sin stocks’ or claim to rely on ESG.EVELYN HOCKSTEIN/Reuters

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Investment managers are up in arms about U.S. plans to revamp the rules around fund names, saying they will discourage stock-picking and other active management and threaten to undermine financial stability.

The Securities and Exchange Commission (SEC) is trying to crack down on misleading marketing by requiring funds to prove that 80 per cent of their holdings match their names. The proposal under chair Gary Gensler would apply to everything from “core” and “growth” funds to those that purport to invest in “sin stocks” or claim to rely on environmental, social and governance (ESG) investing factors.

This “names rule” has been around for 20 years but applied mostly to concrete terms such as “bond” or “equity” and excluded thematic investment strategies explicitly.

Consumer groups say the expanded rule is needed badly to address funds that rechristen themselves “ESG” without making any meaningful changes to their investment strategies as well as those that drift from their advertised purpose.

“We wholeheartedly support this proposal,” says Stephen Hall, legal director of Better Markets, a financial reform group. “Investors need to know that their funds are being invested in the way that they expect. The name is a very powerful influence.”

More than 105 fund companies and investors have filed public comments on the proposal ahead of next week’s deadline, and SEC officials have reported holding 11 meetings with industry groups.

The asset managers argued that there are dangers to tying funds to a specific definition of acceptable assets and holding them to it daily. Concepts such as “income” or “value” vary depending on market conditions, and binding a fund to a specific metric runs the risk of turning actively managed funds into glorified tracking products, they said.

“This proposed expansion of scope is an overly broad and unhelpfully blunt solution,” wrote Capital Group, the Los Angeles-based active manager, in a letter to the SEC.

The firm cited a specific problem with small-cap funds: a portfolio manager may buy a small company and hold on to it as it grows, only to be forced to sell when it crosses an arbitrary threshold.

Invesco Ltd. pointed out that in June, Facebook’s parent, Meta Platforms Inc. META-Q, moved from being part of the Russell 1000′s growth index to being part of its value index, and warned that forced selling would add costs for investors.

Fidelity Investments, meanwhile, wrote that it was concerned by the part of the rule that gives funds that are out of compliance with the 80 per cent rule 30 days to remedy the situation.

“By prescribing a rigid set of conditions, the Commission may be unintentionally hampering a fund’s ability to meet new and unforeseen challenges,” the firm wrote, arguing that 180 days would be more appropriate.

If prices move violently, the 30-day deadline could become a stability risk, fund experts said.

“Imagine something goes massively wrong or massively right with a particular sector,” says George Raine, a partner at Ropes & Gray LLP who specializes in fund management.

“It becomes a ticking time bomb. Everyone knows that after 29 days, there are going to be all of these mutual funds that are going to have to sell or buy.”

The Investment Company Institute, the main industry lobby group, says the proposed rule would increase costs because 92 per cent of funds would have to develop new systems to monitor for daily compliance. The SEC’s own estimates put the cost to the fund industry at up to US$5-billion. The agency declined to comment.

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