The MDFP: Key Elements to Include in Form N1-A and N-CRS

What Every Fund Manager Should Know About Writing a Shareholder Letter

On October 26, 2022, the Securities and Exchange Commission (“SEC”) adopted rule and form amendments that modernize the disclosure framework in shareholder reports. The rule amendments, which apply to mutual funds and exchange-traded funds, became effective January 24, 2023, and are intended to highlight key information to shareholders in the semi-annual and annual reports.

The SEC routinely examines annual reports under the Sarbanes-Oxley Act of 2002. As part of these exams, the SEC reviews the Management Discussion of Fund Performance (“MDFP”) which is required for annual reports and optional for semi-annual reports. Below is a list of requirements that fund managers need to incorporate into their MDFP letters to shareholders.

Because the MDFP letter will be read by shareholders and reviewed by the SEC, fund managers need to carefully prepare and review the letter to make sure that it not only captures the requirements of Forms N-1A and N-CSR but also articulates the performance and risks of the fund and the manager's ability to deliver value to shareholders.

MDFP Requirements Under SEC Rules

Fund managers are required to discuss the key factors that materially affected a fund's performance during the most recent reporting period, including:

1. the relevant market conditions;
2. the investment strategies and techniques used by the fund's investment adviser during the fiscal period;
3. A comparison of the fund's performance to its primary and any secondary benchmarks;
4. the impact of significant portfolio holdings such as the top five drivers and detractors of fund performance; and
5. A discussion of the fund's primary risks and how the adviser manages them.

The discussion may include narrative, statistical, and graphical data on these key factors. The discussion should be clear, concise, and easy to read for the average investor (i.e., a retail investor, not an institutional investor). The discussion should also be objective and balanced and not a promotion of the fund or the adviser.

Suggested Topics for the MDFP Letter

Appropriate topics to discuss in the MDFP include:

• The fund's investment performance over the past year, quarter, and three- and five-year periods.
• The fund's investment strategies such as the asset classes, sector or industry exposure, and investment style used by the adviser.
• Market conditions and economic factors that impacted the fund's performance (e.g., monetary policy by the Federal Reserve, economic crises, government policies, natural disasters, war, etc.).
• How the adviser managed the principal risks of the fund's investment strategy, such as hedging or defensive measures taken to limit such risks.
• Discuss the adviser's market outlook for the next fiscal year.

Tips for MDFP Letters to Cover Multiple Funds

1. Start with an introductory paragraph that discusses the macroeconomic and market events that affected all funds.
2. Next, break the letter into sections covering each fund or similar funds (e.g., equity versus fixed-income funds). For each section, include a paragraph on:
   1. fund performance over recent and longer terms (e.g., one, three, five, and ten years since inception);
   2. most significant contributors and detractors (use the same number of positions for both; we recommend no more than five); and
   3. the fund's investment strategy and the adviser's investment processes.
3. Finish with a market outlook that covers all the funds.

If you have any questions on MDFP letters and how best to curate them, don't hesitate to reach out to the FinTech Law team.