Browse Analysis of Managed and Structured Products

17.6.2 Mutual Fund Restrictions

Comprehensive guide to mutual fund restrictions including management limitations, regulatory controls on derivatives, prohibited selling practices, and detailed reporting requirements for mutual funds in Canada.

Mutual Fund Restrictions

A mutual fund’s manager provides day-to-day supervision of the fund’s investment portfolio. In trading the fund’s securities, the manager must observe several guidelines specified in the fund’s charter and prospectus, along with constraints imposed by provincial securities commissions.

Restrictions on Mutual Fund Management Practices

The management of a mutual fund portfolio involves adherence to a variety of restrictions, which vary from fund to fund. Here are some common limitations:

  • Issuer Proportion: Purchases limited to no more than 10% of the total securities of a single issuer or more than 10% of a company’s voting stock.
  • Manager’s Own Company: No investment in the shares of the manager’s own company (e.g., a bank-owned fund cannot buy shares in that bank).
  • Net Asset Allocation: No more than 10% of the net assets in securities of a single issuer or 20% in companies within the same industry, save for specialty funds.
  • Other Mutual Funds: No purchases in other mutual funds unless there is no duplication of management fees.
  • Leverage Prohibited: No borrowing for leverage purposes.
  • Margin Buying/Short Selling: Strict no to margin buying or short selling.
  • Commodities and Futures: No commodity or commodity futures purchases.
  • Illiquid Securities : Limits on holdings in illiquid securities such as private placements or unlisted stocks.

Use of Derivatives

Mutual fund managers are tightly regulated with respect to derivatives—financial contracts whose value hinges on underlying assets like commodities, stocks, bonds, or indices. Allowed derivatives include options (puts and calls), futures, forwards, rights, warrants, and combination products.

Common Uses of Derivatives

  • Hedging: Mitigating risk through instruments like put options.
  • Facilitating Market Entry/Exit: Utilizing derivatives to manage market participation efficiency.


A fund manager concerned about a potential market decline could purchase put options on the iUnits S&P/TSX 60 Index Fund (i60s). If the market dips, the loss in portfolio value would be countered by gains in the put options.

Regulatory Controls

Derivatives regulations include:

  • Investment Cap: Max 10% of net assets in derivatives.
  • Hedging Requirement: Derivatives positions must be hedged according to daily valuations of fund assets.
  • Expiry Dates: Specific terms for options and futures.
  • Professional Qualifications: Detailed advisor qualifications to trade.

Exempted from these rules are hedge funds and alternative mutual funds. These products, detailed in later chapters, allowed speculated by leveraged derivatives.

Prohibited Selling Practices

Certain practices are forbidden to ensure ethical conduct:

  • Future Price Predictions: Quoting future or back-dated prices is unlawful.
  • Repurchase Offers: Pledging to repurchase to shield clients from price drops is banned; normal redemption rights persist.
  • Licensing and Registration: Selling without appropriate licensing or handling unauthorized securities is illegal.
  • Advertising Registration: Implies unsanctioned regulatory approval, hence prohibited.

Any promotional activities must comply entirely with NI 81-102 and NI 81-105.

Guidelines and Restrictions

Broad guidelines aim to regulate fund management behavior with clear dos and don’ts, including commission changes, subsidizing expenses, and providing non-significant gifts.

Sales Communications

Any form of communication (written, oral, or advertising) must be honest and rigorous, ensuring transparency and comprehensive disclosure. No misleading information or unproven performance claims are allowed.

Communicating Rates of Return

All performance communications must abide by industry standards like time-weighted or dollar-weighted returns approved by the Global Investment Performance Standards.

Performance Reporting Requirements

Under MFDA rule 5.3.4, annual reports detailing asset market values, deposits, withdrawals, and percentage returns must be provided to clients.

Key Takeaways

  • Mutual fund managers follow strict guidelines on portfolio composition and conduct.
  • The use of derivatives by mutual funds is regulated with detailed restrictions on their purposes and limits.
  • Prohibited practices in sales and promotion exist to ensure ethical standards.
  • Comprehensive and transparent communication about performance and rates of return are mandatory to protect investor interests.


  • Net Asset Value per Share (NAVPS): The value of a mutual fund’s assets minus its liabilities, divided by the number of shares outstanding.
  • Put/Cash Options: Financial instruments granting the holder the right to sell (put) or buy (call) an underlying asset.
  • Illiquid Securities: Securities that cannot be quickly sold without significantly affecting their price.

Frequently Asked Questions (FAQs)

Q1: What are the primary reasons for restrictions on mutual fund managers? A: To protect investors by ensuring diversified and ethical investment practices.

Q2: Can mutual funds use derivatives for speculation? A: Generally no; regulations mandate derivative use primarily for hedging and market transition, except for alternative mutual funds and hedge funds.

Q3: When are mutual fund performance reports shared with clients? A: Minimally, once per year, covering at least a 12-month period.

CSC® Exams Practice Questions

📚✨ CSC Exam Questions ✨📚

Welcome to the Knowledge Checkpoint! You'll find 10 carefully curated CSC exam practice questions designed to reinforce the key concepts covered. These questions will help you gauge your grasp of the material, identify areas that need further review, and ensure you're on the right track towards mastering the content for the Canadian Securities certification exams. Take your time, think critically, and use these quizzes as a tool to enhance your learning journey. 📘✨

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## What is the maximum percentage of a mutual fund's net assets that can be invested in the securities of a single issuer? - [ ] 5% - [x] 10% - [ ] 15% - [ ] 20% > **Explanation:** A mutual fund manager can invest a maximum of 10% of the fund's net assets in the securities of a single issuer. ## When handling mutual fund securities, a manager is restricted from purchasing shares of which of the following? - [x] Their own company - [ ] Any Canadian company - [ ] Any technological company - [ ] Any industrial company > **Explanation:** Mutual fund managers are restricted from purchasing shares in their own company to avoid conflicts of interest. ## Under which condition are mutual funds permitted to invest in the shares of other mutual funds? - [ ] Always - [x] If no duplication of management fees occurs - [ ] If the funds are in the same industry - [ ] If the funds are managed by the same manager > **Explanation:** Mutual funds can invest in other mutual funds only under certain conditions, such as when no duplication of management fees arises. ## Which of the following investment practices is prohibited for mutual fund managers? - [ ] Investing in bonds - [ ] Investing in stocks - [x] Margin buying or short selling - [ ] Investing in ETFs > **Explanation:** Mutual fund managers are prohibited from engaging in margin buying or short selling. ## What stipulation exists for the use of derivatives by mutual fund managers? - [x] They must be used to hedge risk and facilitate market entry/exit - [ ] They can be used to speculate freely - [ ] They can cover only 5% of the fund’s net assets - [ ] They must only be used occasionally > **Explanation:** Mutual fund managers can use derivatives primarily to hedge risk and facilitate market entry or exit, but speculative use is restricted. ## What is the legal status of backdating a mutual fund order to obtain a previous day's NAVPS? - [ ] Allowed with client consent - [ ] Allowed if disclosed - [ ] Allowed before the market closes - [x] Unlawful > **Explanation:** It is unlawful for a representative to backdate an order in an attempt to buy or sell shares or units at a previous day's price. ## What practice is prohibited regarding mutual fund advertisements? - [x] Advertising registration with a securities authority - [ ] Advertising fund performance - [ ] Comparing the fund with an index - [ ] Describing fund characteristics > **Explanation:** Advertising or promoting the fact that one is registered with a securities authority is prohibited as it implies endorsement beyond regulatory approval. ## How soon must a mutual fund representative be registered in a new province when planning to sell mutual funds? - [ ] Within one month of the sale - [ ] Within six months of the sale - [ ] Only if requested by a client - [x] Before making any sales > **Explanation:** A mutual fund representative must be registered in each province where they intend to sell mutual funds before engaging in any sales activity. ## What percentage of a mutual fund's net assets can be invested in derivatives according to regulations? - [ ] 5% - [ ] 15% - [x] 10% - [ ] 20% > **Explanation:** Regulations stipulate that the total amount invested in derivatives cannot exceed 10% of the net assets of a mutual fund. ## Which reports must mutual fund representatives provide annually to clients, according to MFDA Rule 5.3.4? - [ ] Monthly performance reports - [ ] Quarterly performance reports - [x] Annual performance reports - [ ] Semiannual performance reports > **Explanation:** According to MFDA Rule 5.3.4, mutual fund representatives must provide clients with an annual performance report covering at least a 12-month period.

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Sunday, July 21, 2024