What constitutes a “current market condition” that mutual funds are required by SEC regulations to disclose? Current market condition risks arise because of changing market conditions that can affect investment performance. For some U.S.-registered funds, Covid-19 is prompting new event-specific disclosures. In 2020 Q1-Q3, we see a dramatic increase in public health-related disclosures overall, and the emergence of new Covid-19 and quarantine risk disclosures.
While the SEC hasn’t mandated Covid-19 disclosures or provided guidance to funds (as it has with operating companies), it is clear that funds are not immune to the effects of Covid-19. For example, the SEC has relaxed its rules on in-person fund board management meetings, allowed for between-fund borrowing, delayed delivery of fund prospectuses and other information, issued investor fraud alerts around Covid-19, and published a COVID response page for funds on its website.
The onslaught of the Covid-19 global pandemic provides a natural event study for which funds disclose Covid-19 and how they do it. Our Mutual Fund Disclosure research group at Georgia State University’s Legal Analytics Lab started tracking Covid-19 disclosures after spending the last few years compiling and text-mining mutual fund prospectuses to develop theories of fund disclosures, test compliance with SEC regulations and guidance, and model financial performance and risk (see e.g., Promise and Perils of Plain English). In prior work studying disclosures from 2010-2018, we tracked language mirroring SEC guidance on current market conditions, as indicated by language such as “persist or worsen,” “not yet known,” etc. We found that, on average, 8 percent of investment companies disclosed changing market condition risks, with fixed income funds disclosing the most frequently.
Few funds disclosed public health related events as a current or static market condition over the past decade as compared with other potential current market conditions. Compare, for example, Figure 1, displaying the number of various public health-related terms included in risk disclosures, and Figure 2, plotting the number of natural disaster mentions in fund risk disclosures. The number of public health citations is relatively small and remains relatively flat from 2010 to 2019. Natural disasters are cited as risk factors far more frequently – a trend that has mostly increased over the last decade.
Figure 1: All Fund Public Health Keyword Count (log) by Year
Figure 2: All Fund Natural Disaster Keyword Count (log) by Year
Funds first introduced Covid-19 and pandemic-related disclosures in 2020 – a trend accompanied by an increase in public health disclosures unrelated to Covid-19. In the first three quarters of 2020, 769 funds disclosed public health events. Of these 769, domestic equity funds comprise 191 – by far the largest fund class. Despite increases in severe storms and wildfires, however, funds failed to meaningfully increase disclosing natural disaster events as compared with previous years.
Funds characterized the public health risks associated with Covid-19 in a variety of ways, ranging from “disease” generally to specific concerns about “quarantines” and “sanitation.” Figure 3 breaks down funds’ public health reference by token (word), number of funds using the term, and CRSP class. Figure 3 also highlights domestic equity funds, the type most likely to disclose Covid-19 as a current market condition.
Figure 3: 2020 Public Health Keywords (with callout blocks for terms unique to 2020)
An appraisal of the full text of fund disclosure reveals that funds frame pandemic-related risk as a “current market condition.” The disclosure below describes what the fund views as a market-wide risk on domestic equity:
“The possibility that common stock prices will decline over short or extended periods of time due to overall market, financial, and economic conditions and trends, governmental or central bank actions or interventions, changes in investor sentiment, and other factors, such as the recent covid-19 pandemic, that may not be directly related to the issuer of a security held by the fund.”
Covid-19–specific language accounts for 34 percent of the 2020 public health disclosures and addresses themes such as global markets, lagging consumer spending, volatility, value, and investment specific risks such as interest rates, real estate, and commodities. For example:
“The effects of this pandemic to public health and business and market conditions, including exchange trading suspensions and closures, may continue to have a significant negative impact on the performance of the funds investments, increase the funds volatility, exacerbate pre-existing political, social and economic risks to the fund, and negatively impact broad segments of businesses and populations. In addition, governments, their regulatory agencies, or self-regulatory organizations may take actions in response to the pandemic that affect the instruments in which the fund invests, or the issuers of such instruments, in ways that could have a significant negative impact on the funds investment performance. The full impact of the covid-19 pandemic, or other future epidemics or pandemics, is currently unknown. For example, the outbreak of covid-19, a novel coronavirus disease, has negatively affected economies, markets and individual companies throughout the world, including those in which the fund invests.”
The remaining 66 percent of 2020 public health disclosures are generic, boilerplate statements – but the increase in frequency suggests a relationship to the global pandemic. For example, such language cites generally to “geopolitical and other risks, including environmental and public health risks may add to instability in world economies and markets.” Money market funds’ disclosures were most likely to contain boilerplate language (82 percent) of public health disclosures. In contrast, index and domestic equity funds were much more likely to cite specifically to the coronavirus pandemic as the source of public-health risk. Breakdowns by fund type are included in the table below.
The emergence of Covid-19 disclosures in mutual funds also reflects the flow of information from operating company disclosures to fund disclosures when reporting on portfolio risks. In the first three quarters of 2020, 16.5 percent of fixed income funds disclosed public health risks. These disclosures are likely the result of May 2020 SEC guidance to issuers of municipal securities to provide as much information about current and operating conditions because the “fluid and unpredictable nature of the public health crisis and its financial and economic impacts on municipal issuers…” This guidance is reflected in subsequent fund disclosures, such as: “[T]he novel coronavirus (covid-19) pandemic has significantly stressed the financial resources of many municipal issuers, which may impair a municipal issuers ability to meet its financial obligations when due and could adversely impact the value of its bonds, which could negatively impact the performance of the fund.”
While our findings shed light on funds’ compliance with current market-condition disclosure guidance from the SEC, it also raises additional questions. Why do we observe variation among fund types in disclosing public health risks? Among those that do disclose public health risks, why do we see variation between use of boilerplate and pandemic-specific language? More important, to what extent do these differences reflect substantively meaningful differences in fund performance and risk for years to come?
 Our full list of keywords included “not yet known;” “persist or worsen;” “continues to face;” “continues to experience;” “current market;” “recent events;” or “ongoing.”
 Domestic equity growth/income, foreign equity real estate, domestic equity sector funds (natural resources, commodities), and mortgage backed security funds disclosed current market condition risks in 10 percent or more filings.
 Figures 1 & 2 show the log of counts to display the low counts of public health disclosures years 2010-2019 compared with the high keyword counts in 2020. We retain the log representation in Figure 2 to provide a comparison between the keywords of interest. Public health and natural disaster keywords were generated through a combination of computational and manual reviews. We have 31 key words for public health and 27 for natural disasters. See https://sites.google.com/view/gsu-mutual-fund-research for a complete list of keywords and additional data. We also note the dip in counts for 2019 in both graphs.
This post comes to us from professors Anne M. Tucker, Yusen Xia, and Susan Navarro Smelcer at Georgia State University. It is based on their mutual fund disclosure projects, detailed here.