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Trust fund has a profile


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The ISA is initiating a proposal that will obligate trust funds to classify themselves in accordance with the level of the trust funds’ exposure to investment in shares and foreign currency. This step will turn the Israeli trust fund market, considered to be one of the most transparent ones, into an even more transparent one. The exposure profile, as part of the fund’s classification that includes new headings characterizing the fund, is expected to improve transparency and to make the disclosure more effective.
During the years a tradition has been established in Israel, whereby the investment policy of trust funds is formulated, mainly, in terms of obligations to hold various shares at a rate relative to the net value of the funds’ assets (“most of the fund’s assets shall be invested in shares”, “between 20% and 50% of the fund’s assets shall be invested in bonds linked to the foreign currency index “, etc.). This tradition brought about the classification of trust funds according to the dominant securities they hold, as can be deduced from their investment policy. As long as fund managers didn’t deal in options, futures and short sales the aforesaid tradition was sufficient to classify funds and stipulate criteria for naming them.
Once the funds in Israel started to deal in derivatives the rules of the game had changed: due to the leverage embedded in derivatives – it is possible to expose the price of a unit, by investing just a few percents of the fund’s assets, to changes in the base asset of the option, at a rate equivalent to direct investment in the base asset in tens (and at times in hundreds) of percents of the fund’s assets. It is obvious that under these circumstances the information pertaining to the option value as a rate of the fund’s assets is not relevant, since the call option is not the same as a put option and long options are different from the short options. Another difficulty arises as a result of the transactions in futures, activity that finds no expression in the value of the fund’s assets while the leverage embedded in it is great.
A representative example: trust fund designated as a “NIS fund” (since at least 90% of its assets are invested in NIS), whose investment composition is 95% in NIS and 5% in options of “Tel Aviv 25 Index” can, at some point in time, experience price fluctuations as if it were a regular “shares’ fund”. The risk pertaining to the aforesaid activity is not explicit, since under the existing situation the name of a fund or its classification in various publications (“NIS fund”, “Bonds’ fund”, “shares’ fund”, “foreign currency fund”, etc.) and the estimation of the derived risk are stipulated, exclusively, in accordance with dominant securities – as a rate of the fund’s assets.
As part of the extensive reform, lead by the ISA, pertaining to the classification of funds in Israel, it was decided to pave a simple way for each fund to present the effects of its activities in derivatives on the various assets it holds. The first step in this direction has, already, been taken a few months ago in defining the type of fund for setting the distribution commissions’ rate. The chosen definition pertains to characteristics of the fund’s investments – “NIS fund”, “Bonds’ fund”, “shares’ fund”, etc, by using exposure’s terms related to shares and not to the value of holdings in those shares.
The next step is – regulating media advertising pertaining to the data published by a mutual trust fund, as well as pertaining to the immediate reports, which are published on MAGNA about fund’s classification.
In order to arrive at a simple, user friendly, evaluation method we have found it appropriate to translate the information, pertaining to exposure, into a pair of characters relaying this information. It was decided to name this pair of characters – Trust Fund’s Exposure Profile. It is intended to create a situation where the aforesaid profile will simplify the information related to fund’s exposure to fluctuations in the prices of its assets, in the same way succession of characters simplifies the classification of bonds – concerning issuer’s insolvency (the knowledge that bonds classified AAA are safer then bonds classified BBB – is public knowledge).
Analyzing funds’ activity shows that there are two major factors influencing fund’s fluctuations – fund’s exposure to shares (including merchandise) and fund’s exposure to foreign currency. These two basic assets vary in the accepted risk ascribed to each one of them (shares, merchandise etc. – considered to be riskier then foreign currency).
As a result of the ISA initiative, every fund manager will be required to define the maximal exposure rate for each of the basic assets, as part of the fund’s investment policy, according to the following table:
Maximal exposure
rate per asset
Shares Foreign currency
0% 0 0
10% 1 A
30% 2 B
50% 3 C
120% 4 D
200% 5 E
Above 200% 6 F
Addition of information, regarding maximal exposure classification to each of the basic assets, will be done by means of two characters – the right hand characters indicates level of exposure to foreign currency, the left hand character – exposure to shares; thus, exposure profile of the fund will become an integral part of its classification criteria.
A number of examples:
1. Pure “NIS fund” shall be classified 00. A fund that will “spice” its investments by exposure to shares will be clearly identified and its profile will be between 10 and 20, accordingly. A fund whose profile will
be 30 and higher, will not be allowed to designate itself as the “NIS fund”, due to the significant influence
of the share component.
2. The exposure profile will also allow to identify and quantify the influence of “other noises”, within the “Bond funds”, and will assist in evaluating the funds’ performance, by taking into the consideration the risks taken by its manager, risks expressed in actual investment characteristics and in the exposure profile – a fund of government index linked bonds, with profile 10, differs from a fund rated 20 (without exposure to foreign currency and shares at the rates between 10% and 30%, respectively).
3. A fund exposed by 100% to Nikkey 225, through shareholding, shall have the exposure profile of 4D. A fund exposed by 100% to Nikkey 225, through derivatives, shall have the exposure profile of 4A. This means that the first fund is affected by changes of the Nikkey 225 index, and also by the changes in Yen’s exchange rate. By comparison, the second fund will be significantly affected by the changes of the Nikkey 225 index only.
As part of the funds’ classification, the exposure profile will contain new headings characterizing these funds and providing supplementary information, which is expected to improve the transparency and make the disclosure more effective. This is a particularly important step since despite the availability of information, pertaining to mutual funds, to the public (prospectuses, immediate reports, monthly investment composition, etc.) through MAGNA, most of the public still relies on the newspaper as the main tool for choosing the fund– exposure profile will be part of the information published in the papers on mutual trust funds.

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