Investment decisions of portfolio managers | Finance and Investment

In Turpin, the plaintiff argued that TDAM has policies or procedures that cause the Canadian Equity Fund (“CEF”) to closely track a benchmark index. According to the applicant, these policies limit the discretionary power of the manager in the management of the fund. This has the effect of limiting the risks that the portfolio manager can take and preventing the CEF from outperforming the benchmark index. The plaintiff denounces this investment strategy since it is not consistent with the publicly declared objective of the fund.

The court concluded that TDAM did not act or implement policies or procedures that would have
limited the portfolio manager’s room for maneuver in his management of the CEF. If the implementation of such policies had been proven to be correct, there would indeed have been a basis for the plaintiff’s action given the stated objective of the CEF, which was to outperform the performance of the benchmark index. However, the evidence presented at trial demonstrated instead that the portfolio manager took risks and adopted an investment strategy whose true goal was to outperform the benchmark index. The court explains that it would not be appropriate to express doubts or interfere with the judgment of managers by having the benefit of hindsight.

Use of financial metrics and investment reasoning should be documented

In Turpin, in order to determine whether there was a question of a fund reproducing only the reference index (closet index fund) without active investment management, the court analyzed different financial measures. According to her, financial measures can be useful to detect a fund that only reproduces the benchmark index. However, the court wrote that it is also necessary to conduct a more in-depth qualitative examination of the underlying circumstances to reach the conclusion that there was a strategy in place truly intended to reproduce only the benchmark index.

To determine whether there was “active management”, the court took into account the investment motives of Mr. O’Brien, the fund manager. Although not required by TDAM or securities regulations, the fund manager recorded his investment reasons in a checklist. This allowed the court to conduct a qualitative review of the fund and conclude that, although the CEF is close to the benchmark, it is not a fund that merely replicates it. Indeed, the contemporary investment motive notes made no mention of the benchmark index. Portfolio managers should therefore be encouraged to keep contemporaneous notes on the rationales for their transactions since the court may take them into account when determining the investment strategy actually used.

Key principles to remember

In conclusion, the Turpin affair highlights the importance of trust placed in portfolio managers in their investment decisions, as long as they are taken in good faith and in the interests of unitholders. The court emphasized that it cannot interfere with the judgment of portfolio managers retrospectively. Using financial metrics can be helpful in detecting closet index funds, but a qualitative examination of the circumstances is also essential in establishing the actual investment strategy. Finally, this case reminds managers to keep contemporaneous notes justifying their decisions.

Julie-Martine Loranger is an emeritus lawyer, partner at McCarthy Tétrault SENCRL,

srl, with the collaboration of Me Pierre-Gabriel Grégoire, CPA and lawyer at McCarthy Tétrault, and Maria Caria Chiara and Vincent Leduc, law students at McCarthy Tétrault. This article does not constitute legal advice.

[1] Turpin c. TD Asset Management, 2022 BCSC1083.