governance interview (proposal mar2010)

‘Do funds do what they say?’

My proposal for fund governance across different asset classes..

March 2010Jon Beckett, ASCI

Chasing a Holy Grail?

"Any intelligent fool can make things bigger and more complex... It takes a touch of genius - and a lot of courage to move in the opposite direction."

Albert Einstein

Governance: Do Funds do what they say?

Simple

Complex""... a speculator is one who runs risks of which he is aware and an investor is one who runs risks of which he is unaware.“

John Maynard Keynes

Treating Customers Fairly

“Consumers are provided with products that perform as firms have led them to expect and the associated service is both of an acceptable standard and as they have been led to expect..”

‘Treating Customers Fairly: Measuring Outcomes’ Outcome 5: FSA Progress Update June 2008


TCF #5TCF #5

Morale hazards

“There are 2 kinds of rugby players - there's the honest ones and then the rest.”

Jim Telfer, 1997 Lions tour


Building a Framework

TCF Outcome 5TCF Outcome 5Products not performing in

line with:

1. Investor expectations2. Investment guidelines3. On the basis sold


Sector Volatility FOREXCredit &

IssuerMarket (Beta)

Inflation & Interest

Counter-party Liquidity

Cash x x x x

Structured x x x x

Bond x x x x x

Equity x x x x

Commodity x x x x

Property x x x x x x

Derivative x x x x x x

Expected behaviours?


Unexpected behaviours?

Positive Distribution – Cash FundPositive Distribution – Cash Fund(R)(R) Change in sector classification to riskier peer group.

(R)(R) Presence of non-Cash, CDO, CMBS, ABS etc

(A)(A) Nominal Return below LIBOR, poor Real Rate of Return

(A)(A) Excessive positive returns (E..g +100bps >LIBOR)

(A)(A) Use of non-deposit short-term paper, gilts

(A)(A) Monthly returns dip below LIBOR/SONIA

(A)(A) Redemptions or Falling assets

(A)(A) Rising Volatility of returns

Uniform Distribution – Gilt or Bond FundUniform Distribution – Gilt or Bond Fund(R)R) Sovereign downgrade of core holding(s)

(R)(R) Heavy use of CDS and derivatives

(R)(R) Rising Correlation to Equities and HY

(A) (A) Multiple netting agreements, strips etc

(A)(A) Long and rising Duration/Maturity

(A)(A) Falling Yields/Narrowing Spreads

(A)(A) Growing negative skewness; rising Kurtosis

(A)(A) Tracking Error above benchmark limits

Normal Distribution – UK Eq Income FundNormal Distribution – UK Eq Income Fund(R)(R) Maximum Loss in excess of expected

(R)(R) Large reduction in yield pay-out

(A)(A) High Cash (close or above IMA limits)

(A) (A) High P/Earnings, Low or falling P/Cash Flow

(A)(A) High 12mo portfolio turnover relative to peers

(A)(A) Change in mandate to allow non-Equities

(A)(A) High non-UK exposure

(A)(A) Downgrade of FMR from S&P

Left-Tail Distribution – EM Equity FundLeft-Tail Distribution – EM Equity Fund(R)(R) High concentration in single country (E.g. China)

(R)(R) High XS Value at Risk, frequent violations

(R)(R) Fund manager change, high team turnover

(A)(A) Rating downgrade of core countries held

(A)(A) Large swings in quartile deviation

(A)(A) Excessive Liquidity into/out of Sector

(A)(A) Significant dispersions away from sector

(A)(A) High TER, non-performance linked

Distinct sets of KRIs per category!

Bell

Uniform

Left-tail


Conventional attribution: standard time period average.

Dispersion - Attribution


Targeted attribution: standard time period to date of request. Check for changes: E.g.

• Mandate or benchmark• Portfolio holdings• Percentile ranking • Quartile deviation, inter-quartile range• Tracking Error (R2)

“Only takes one tree, to make a thousand matchesOnly takes one match, to burn a thousand trees”

Stereophonics, 1997

MI & Analysis

• Identify risk: build framework• Baseline expected behaviours• State unexpected behaviours (KRIs)• Methodical flow of questions• Common score across Funds• Thresholds and escalation


The KRI score is directly linked to the number of ‘Yes’ responses in the logic test:

The test is summarised as a score, as shown above (6 ambers + 2 greens + 0 reds = total score of 8):

Appendices

1. Escalation2. Thresholds3. Holding Periods4. Histograms5. Tracking Maps

Summary


Escalation:

(R)(R) (R)(R) (A)(A)

(A)(A) GG(A)(A) (G)(G) (G)(G)

(A)(A)

(A)(A)

(A)(A)(A)(A)

Q. Maximum Losses and/or Drawdowns rising above expected outcomes and previous water lines? Yes/NoNo

Q. VaR greater than expected for strategy, sector?Yes/NoNo

Q. Rising Negative Skewness, Volatility or other downside indicators?YesYes/No

Q. Redemptions in excess of 10% of tna; within 3months, or coupled to zero/flat gross sales? Yes/ No

Q. Unusual Correlation to Benchmark/ peers, Attribution or risk factors (E.g. Barra)YesYes/No

Q. VaR continuing to rise, risk of violations above permitted number for model?Yes/NoNo

Q. Any unexpected turnover, cash, concentrations or portfolio indicators?Yes/NoNo

Q. Any unexpected drop off in performance or rising volatility?Yes/NoYes/No

Q. Recent material changes in the Fund?YesYes/No

Q. Unusual sector flows/redemptions (E.g. herding, momentum or retraction)?YesYes/No

(A)(A)

Alert for systemic issuesAlert for systemic issues Business as usualBusiness as usual

Act

ions

A

ctio

ns

for

fo

r

Rem

edy

Rem

edy

Q. Excess redemptions or sales volatility over sector peers?YesYes/No

Q. Do redemptions appear to have impacted falling performance?Yes/NoNo

12 (R)

11 (R)

10 (A)

9 (A)

8 (A)

7 (A)

6 (A)

4 (A)

2 (G)

5 (A)

3 (A)

1 (G)

(R) Red (R) Red (Action to remedy)(Action to remedy)

(A) Amber (A) Amber (Alert for issues)(Alert for issues)

(G) Green (G) Green (Business as usual)(Business as usual)

Appendix 1


MI: Managing Thresholds

Appendix 2


Appendix 3

Holding Periods


Expected Behaviours: Histograms (IMA)

IMA UK Index-Linked Gilt

IMA Global Emerging Mkts

IMA North America

IMA Global Growth

Appendix 4


Reporting: Seeing the big picture at a glance..

Appendix 5


governance interview (proposal mar2010)

Documents

expected behaviours

runs risks

tracking error

quartile deviation

rising volatility

high

expected

cash