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Securities Law

NIN 87/67 - Leveraged Mutual Fund Purchases [NIN - Rescinded]

Published Date: 1987-10-09
Effective Date: 1987-10-09
The B.C. Securities Commission has a strong concern that the practice of leveraging mutual fund purchases is increasing and that excessive leveraging is contrary to the interests of investors and potentially destabilizing for the mutual fund industry.

In an effort to bring to investors' attention the risks of excessive leveraging, all mutual fund dealers will now be required to deliver a disclosure document to prospective purchasers of mutual funds.

The form of disclosure document is attached to this Notice.

DATED at Vancouver, British Columbia, this 9th day of October, 1987.
Doug Hyndman
B.C. Securities Commission
British Columbia Securities Commission

Disclosure Document

Borrowing Money to Buy Investment Funds (Leveraging)

The B.C. Securities Commission requires the delivery of this document to investors who are considering buying mutual funds (investment funds).

Mutual funds may be purchased using available cash, or a combination of cash and borrowed money. If cash is used to pay for the mutual fund purchase in full, the percentage gain or loss will equal the percentage increase or decrease in the value of the fund shares. The purchase of mutual funds using borrowed money magnifies the gain or loss on the cash invested. This effect is called leveraging. For example, if $100,000 of fund shares are purchased and paid for with $25,000 from available cash and $75,000 from borrowings, and the value of the fund shares declines by 10% to $90,000, your equity interest (the difference between the value of the fund shares and the amount borrowed) has declined by 40%, i.e. from $25,000 to $15,000.

It is important that an investor proposing to borrow for the purchase of mutual funds be aware that a leveraged purchase involves greater risk than a purchase using cash resources only.

To what extent a leveraged purchase involves undue risk is a determination to be made by each purchaser and will vary depending on the circumstances of the purchaser and the mutual fund purchased.

It is also important that the investor be aware of the terms of a loan secured by mutual fund shares. The lender may require that the amount outstanding on the loan not rise above an agreed percentage of the market value of the shares. Should this occur, the borrower must pay down the loan or sell the shares so as to return the loan to the agreed percentage relationship. In our example above, the lender may require that the loan not exceed 75% of the market value of the shares. On a decline of value of the shares to $90,000 the borrower must reduce the loan to $67,500 (75% of $90,000). If the borrower does not have cash available, the borrower must sell shares at a loss to provide money to reduce the loan.

Money is, of course, also required to pay interest on the loan. Under these circumstances, investors who leverage their investment are advised to have adequate financial resources available both to pay interest and also to reduce the loan if the borrowing arrangements require such a payment.