It's all in the name: Mutual fund name changes after SEC Rule 35d-1 (2023)

In 2001, the US Securities and Exchange Commission (SEC) introduced Rule 35d-1 to regulate mutual fund names. The rule aimed to address concerns that investors may be misled by fund names that do not reflect their true underlying asset holdings and risks. From 31 July 2001 onwards, Rule 35d-1 requires funds to invest at least 80% of their portfolios in assets suggested by the fund name. The regulatory intervention followed a significant number of fund name changes without corresponding changes in the underlying fund portfolios (Cooper et al., 2005). The issue was highlighted by practitioners in the 1990s:

“An investment in Fidelity's Blue Chip Growth Fund certainly sounds like a stake in America's industrial giants. So shareholders might be startled to learn that their five-year return of 115 percent was achieved by a shift into risky medium-sized companies and international stocks. … The truth is, potato-chip makers are subject to stricter labeling requirements than mutual funds are - and that's a problem for investors faced with more than 7000 stock and bond-fund choices.”

(Source: U.S. News & World Report 1997)

Information about a fund's investments and related risks cannot be captured by the name alone, but the fund name can signal an association with a broad category of investment style. The SEC has recognized the importance of such communication in regulating fund names. In an industry with an increasingly diverse range of products, Rule 35d-1 is meant to reduce investor confusion and aid investors in making appropriate investment decisions.

The controversy over fund names and the adoption of Rule 35d-1 increased the regulatory (compliance) costs to funds of changing their names, which should have reduced funds’ propensity to change names, all else equal. Moreover, one might expect that SEC warnings and Rule 35d-1 made investors more cautious of funds that change their names. As a result, it seems reasonable to expect that Rule 35d-1 would reduce the expected benefits to funds of name changes through abnormal fund inflows by misled investors. If the expected (regulatory) costs to funds of name changes increase, while their expected benefits fall, we would expect to observe comparatively fewer name changes after the adoption Rule 35d-1. While a name change can be useful to communicate a change in some underlying fundamentals of the fund (e.g. a portfolio change), we should expect managers to be more conservative following the new regulation, particularly for name changes that are not motivated by any such fundamental changes.

Our study examines all name changes by US equity funds after the adoption of Rule 35d-1 during 2002(Q4)−2011. Our sample period starts after the publication of Rule 35d-1, and after its compliance date in September 2002, by which time funds with previously misleading names had to have adopted more appropriate names. To our knowledge, this is the first study of mutual fund name changes after the adoption of Rule 35d-1. We have a relatively large sample size of 2677 name changes compared to previous studies, which additionally allows us to explore some of the heterogeneity issues across the fund industry in the context of name changes.

Our study is related to Cooper et al. (2005) who analyse funds that adopt new names that suggest specific investment styles. Based on data before the implementation of Rule 35d-1, Cooper et al. find that name changes give rise to significant abnormal inflows into funds that change their names, particularly for funds that are renamed to reflect recent winning investment categories (‘hot styles’ ). They find that 63% of style-related name changes are ‘misleading’ in that they are not accompanied by corresponding changes in portfolio holdings to reflect the investment style suggested by the new name.¹ We find that misleading name changes continue to occur even after the introduction of stricter regulation through Rule 35d-1, although the proportion is lower at 20% of style-related name changes in our sample.

Following the introduction of Rule 35d-1 and the SEC advice to investors not to base investment decisions on fund names alone, we expect investors to be more wary of fund-name changes and exercise greater caution when investing in funds following name changes. Hence, we would expect investors in the market to treat misleading name changes differently from non-misleading ones. There is no reason to expect abnormal fund inflows in response to the former. Contrary to expectations, we find significant abnormal flows into funds that make misleading name changes. The magnitude of these abnormal flows in the first quarter after the event is comparable to that found by Cooper et al. (2005), although we do not find a substantial long-term affect. Interestingly, we do not find evidence of negative drift in abnormal flows for up to one year post event. It is worth noting that while Cooper et al.’s sample consists of only 332 name changes around certain investment styles, our results are based on a larger, more inclusive sample (2677 changes) that includes all types of name changes in equity mutual funds.

We analyse determinants of short-term and long-term abnormal flows to better understand the drivers of such behavior. Even after controlling for various factors (including marketing and hot styles), we find investors do not differentiate in their reaction between misleading and non-misleading name changes. The non-differential response is seemingly in contrast to expectations following the Rule 35d-1, as investors appear to treat both types of name changes as a positive signal. This investor reaction may be a rational response after all. While a misleading name change may not have a corresponding portfolio change, it may be accompanied by a fundamental change in some other driver of future earnings potential of the fund (such as a change in ownership or management). In such a case, a name change labeled as ‘misleading’ may very well hold information that would be useful to an investor. This leads us to ask a broader question with potentially wider implications: Do investors react differently when name changes are accompanied by fundamental changes to the fund to when they are not?

We address this question by studying investor reaction to name changes that we classify as ‘superficial’ in the sense that they lack a fundamental cause. More precisely, these are name change events not warranted by changes in a fund's investment strategy or holdings, a merger or acquisition, or a change in the fund manager.² We document widespread adoption of such name changes by mutual fund managers; in fact, these constitute a majority (approximately 60%) of all the name changes in our sample period. We further find that such changes are more likely to occur as a response to lower managerial compensation as a result of a shrinking asset base over time and lower management fees (in percentage terms of asset base).

We should not expect investors to react to non-fundamental, superficial name changes as these events contain absolutely no information regarding a change in the future potential earnings of the fund. In contrast to our expectations, however, we find that not only do such name changes attract significantly positive abnormal flows but that these are not significantly different than those of fundamental, non-superficial name changes. This is indicative of a much larger inefficiency in the market than misleading name changes; a superficial name change is approximately four times more likely to occur than a misleading name change (there are only 435 misleading changes in our sample period as opposed to 1605 superficial changes). Interestingly, the magnitude of abnormal flows to superficial name changes is also larger than that to misleading ones. As before, controlling for other factors does not change our findings. We also find no evidence that performance improves after such name changes or that fees decrease, indicating some irrationality on part of investors. Instead, we find that investors tend to lose out due to lower returns to name-change funds as a group.

The rest of the paper is structured as follows. Section 2 reviews the relevant SEC regulation. Section 3 describes our data and methodology. Section 4 outlines and discusses our results. Section 5 concludes the paper.