The OSC recently restricted fund companies’ ability to use industry awards in their advertisements. This news was largely unexpected and has been met with criticism by the industry. The OSC states, “It is staff’s view that awards are, in substance, performance based ratings … The sales communication requirements for mutual funds in Part 15 of NI 81-102 do not permit the use of a performance rating or ranking of a mutual fund that is based partially on a subjective component.”
Ostensibly, the rule regarding advertising performance ratings is meant to prevent fund companies from manipulating the calculations to make a fund’s performance seem more attractive.
As a former Morningstar employee and former Chair of the Morningstar Canadian Investment Awards Committee for many years, I have a thorough understanding of how it works.
Done properly, industry awards can be valuable to the investing public. First, they help distinguish truly exceptional funds from those that are poor or simply mediocre. This is especially true for funds that have won the award multiple times. Furthermore, the awards provide additional incentive to fund companies to produce strong returns since advertising their wins can help attract further investment.
However, as it stands, advisors and investors are left to figure out for themselves which awards programs utilize credible methodologies to select winners. This isn’t an easy task for anyone who doesn’t specialize in evaluating active managers.
Thus, the practice of advertising industry awards does require oversight. Otherwise, opportunistic firms could create awards based on bogus methodology and probably find fund companies willing to accept those awards. Such behaviour happens across many industries.
I applaud the OSC for considering the issue. But the OSC ruled that awards will now be considered a kind of performance ranking. And as such, the advertising of awards is now subject to National Instrument 81-102’s stipulation that prohibits fund companies from using performance ratings or rankings that are based, in any part, on subjective factors.
It is perplexing that the OSC would interpret an award this way. When an investor sees an award for “Best Canadian Equity Fund,” they likely infer it means that the winner is the best in its class. That investor isn’t likely to know what factors are important in determining which fund is “best,” but they likely assume that the experts bestowing the award do.
And the responsible awards providers do have credible methodologies that include criteria that extend beyond historical performance. These criteria would include the quality of the team running the fund, the rigour of the investment process, the cost of the fund, and the stewardship of the organization offering the fund.
Evaluating these factors is inherently subjective. Even the analysis of a fund’s historical performance figures – usually considered a quantitative exercise – requires all sorts of subjective decisions to be made. For instance, what is the appropriate time period to measure? What is the appropriate peer group or index? What measures of risk should be considered? And so on.
The entire notion of quantitative analysis as being somehow more concrete or objective is an illusion. Extracting any meaning from statistics requires subjective decisions to be made. As Benjamin Disraeli famously said, “There are three kinds of lies: lies, damned lies, and statistics.”
Unfortunately, the OSC’s ruling is now likely to encourage awards providers to change their methodologies to rely entirely on quantitative factors. That’s because if they don’t remove the qualitative component to their awards criteria, the current ruling will prevent any fund company from being able to advertise their awards. And what is the point of handing out an award if investors aren’t aware of who the winners are?
Another option is for awards providers to stop handing out awards. But do we really need to run responsible awards programs out of business or encourage them to weaken their awards process by removing the highly beneficial qualitative component?
To be clear, it is commendable that the OSC wants to properly oversee the use of awards advertising. But there is no reason to assume that quantitative criteria are any less subject to manipulation than are qualitative criteria. To my mind, the current ruling actually doesn’t go far enough.
Instead, the regulators should prevent any advertising of industry awards unless the provider has received exemptive relief from the OSC. This would allow the commission to vet awards programs and ensure their methodologies are based on credible criteria, be they qualitative or quantitative.
David O’Leary, CFA, MBA, is managing partner at Eden Valley Partners, a wealth management practice in Toronto.