Looking behind your fund's performance

Fiduciary risk controls are found wanting in the fund management industry in Asia.

With pension reform sweeping across Asia, fiduciary risk is likely to become one of the major measurements when it comes to awarding mandates, according to rating agency RCP & Partners.

While European pension funds, such as the UK Post Office Pension Fund, already require pension managers to be rated before applying for mandates, the trend is yet to take as strong a hold in Asia. RCP & Partners recently compiled scorecards on 50 fund managers in Asia û none attained the top ranking of 'excellent' û but only 35 managers allowed the results to be made public.

As long as a manager can come up with good returns, does it matter how they are achieved? Yes it does, says RCP & Partners chairman Robert Pouliot. He argues that some managers producing strong returns may claim that they are great stock pickers, but without a fiduciary analysis investors cannot determine whether their success is based on luck rather than judgement.

Unlike fund trackers that rank investment funds based on past performance, a fiduciary rating can forewarn investors about the reliability and organizational ability of a manager, in terms of providing a consistent level of performance. And while a credit rating assesses the risk of default by a borrower, a fiduciary rating evaluates a manager's ability to protect and enhance the value of assets entrusted to it by clients.

What is fiduciary risk?

Some managers break fiduciary risk down to market risk, liquidity risk and credit risk. But RCP & Partners groups a manager's fiduciary profile under two families of risks: structural risk and performance risk.

Structural risk focuses on a manager's capital adequacy and control, compliance standards and the level of client services. Performance risk examines the manager's investment process and philosophy, the quality of products offered and the experience of its investment team.

"We've been tracking a group of about 20 managers in Asia, not only in terms of their performance against the MSCI Index but also how they are allocating their investment in Asia. And that was one of the tools that allowed us to come out in May 1997 in Switzerland to forewarn about the upcoming crisis in Asia," says Pouliot. "We were the first and only agency that came out and said there's a high risk of a crisis and there would be a liquidity problem for the managers to move out of the market."

The problem with Asia . . .

Pouliot suggests one problem in Asia is that few managers are long-term driven. He says some managers may claim to have an investment horizon of two years, but are often found to have an annual stocks turnover of around 150%, which is 100% higher than it should be. The fund's performance can therefore be affected as higher turnover increases transaction costs.

Another gripe: Pouliot says many managers, particularly hedge fund managers, often neglect the quality of share execution carried out by their brokers because the manager may have a soft dollar commission arrangement with them. Poor execution produces slippage (the difference between the targeted transaction price and the actual transaction price), which impacts on the fund's performance.

Pouliot stresses his company does not seek to tell managers how they should invest but to warn investors about how factors outside the actual investment techniques can also impact on a fund's performance.

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