Jaitly LLP – Page 5

Why fund and investor domicile matter

Interesting what people can focus on when doing due diligence on funds………. valuations, liquidity, collateral management. But fund and investor domicile? Surely thats something for the lawyers to deal with?

Ethical investing has been around for some time and there are inherent difficulties in the practical application of some of the concepts – but hedge funds have generally never really bothered too much about these aspects being wide and free ranging in their quest for “alpha”. Perhaps the time has come for investment managers to sit up and take a bit more notice. Where their funds and investors are based will have an impact that is starting to go beyond issues of taxation.

On the 10th of July this year Luxembourg – the home to many a fund vehicle – UCIT and non UCIT – ratified a law – article 3 of which when translated reads: “All persons, businesses and corporate entities are prohibited from knowingly financing cluster munitions or explosive submunitions”. Article 4 carries sanctions with 5-10 years detention and fines between €25,000 and €1 million. Luxembourg is unusual in that Ireland which has similarly ratified the convention in relation to cluster munitions with variations as to how it is interpreted/implemented do not currently appear to have defined sanctions for non compliance in relation to investment activity. Belgium and Austria have also adopted laws linked to the signing of the Ottowa convention prohibiting investment activity in businesses involved with the production of anti personnel mines and cluster munitions.

Ireland appears to have protected its fund industry by stipulating that the prohibition (which is no more than endeavouring to avoid) applies to investments where public money is directly invested in equity or debt securities issued by a munitions company. Where it does so the requirement is simply to divest itself of the investment in an orderly manner taking into account any contractual obligations it may have assumed. So apparently not too much to worry about if there is a breach as the sanctions for offences don’t appear to apply to these Part 4 breaches……!

Why is the Luxembourg law relevant – because the actions of the investment manager could have an impact on the investors and on the collective investment vehicle based out of Luxembourg particularly if someone decides to commence with enforcement of this law.

Whilst it has been common to see hedge funds excluding US taxable investors to avoid tax risks we may now begin to see investors and feeders registered in particular countries being excluded as well in order to avoid some of the issues that may arise unless investment managers are prepared to restrict their investment activities so that they fall within the permitted boundaries. It is likely to make trade compliance more onerous for managers as well.

©Jaitly LLP

Investment Management by leaps of faith

It is fascinating to read the marketing presentations of funds of hedge funds about the sophisticated due diligence procedures they employ in making investment decisions.

The reality is that few if any can really consistently perform the procedures they say they apply across all the investments in their portfolios. The simple reason for this is that different hedge fund managers take different approaches to what they will or will not discuss about their businesses. Suffice it to say that larger managers are more likely to be less transparent. Some because of concerns on consistency of disclosure and transparency to investor clients, others because there is no need to because of the clamour for capacity into their funds which means they can ignore those insisting on more information or verification of that information.

Size therefore can determine in inverse proportion the amount of due diligence that may be possible. It therefore stands to reason that if there are large names in a fund of hedge funds portfolio then the chances are that full due diligence has not been performed and “comfort” has had to be obtained from other factors involving a leap of faith based on reputation, assets under management and pedigree.

Does this mean that the investment decision is a wrong one? Not necessarily. But it does highlight the fact that the investment decision may not include all the checks and reviews that might typically be performed during due diligence in relation to an investment. If that is clearly stated in the documentation provided to clients – then that is simply stating the commercial realities of the situation and investors can make their own decisions on the risks and suitability or otherwise of such an investment. I have not seen much evidence of such transparent approaches on procedure which is what leads me to the conclusion that particularly where there are big names in a portfolio, one of the main strands of investment decision making must be leaps of faith.

©Jaitly LLP

Shedding light on Regulation

As regulators scamper to introduce regulation into the world of alternatives one cannot help but wonder whether another opportunity is about to be lost.

The problem with regulation is that it is often a political knee jerk reaction to events. I had for example viewed with some excitement the opportunity the FSA had with the consultations on side letters to address some of the issues that gave rise to the need for such agreements – but the result was a disappointment of weak compromise and the current European regulatory effort seems destined to a similar fate.

Regulation will never save investors from themselves. Investors will forgive almost anything with performance. So what should regulation be designed to address? I prefer a variation to the FSA’s eleven principles as my starting point:

Integrity
Fairness
Transparency
Appropriate business structures and governance
Balance of interests
Protection of interests
Verifiability
Skill and due care

How would these apply to the world of alternatives? I believe it is possible to have a regulatory framework that does not stifle the investment manager but has sufficient clout to bring a manager to heel or to its knees if it misuses the privileges granted to it.

Integrity is a broad over arching starting point and does not require much discussion. Skill and due care whilst clearly important are intentionally placed last on my list – what chance for example does a regulator or an investor have when market participants/managers themselves have no idea of the effects of re-hypothecation in financing transactions – and that is not to condone any of the three groups for that lack of knowledge.

Fairness is central to any financial services transaction – whether in relation to investment terms, fees, manager’s intellectual property or otherwise. When one looks at existing terms and risks that could at least technically be mitigated such as in relation to cross class liability between classes and different levels of leverage then I don’t believe that enough is done by managers to protect investors. I don’t think it is enough simply to disclose the existence of cross class liability – I think the manager needs to be obliged to justify why maintaining that risk is fair to investors. The manager’s argument is that once disclosed it is a matter for investors to determine whether the risk is an acceptable one that of itself is not an unreasonable position until one looks at the rationale applied and the level of due diligence really done by investors. However applying the concept of fairness the manager would need to have taken reasonable steps to protect the classes from cross class liability rather than simply disclosing the existence of the risk and will have explained to the investor why from their point of view the existence of such a risk is fair to the different classes of investors. This argument is important as it is often confused with the principle of transparency – it is never enough in my view simply to disclose – although disclosure is an important step. To go back to my example of re-hypothecation – this was clearly disclosed to those who bothered to read the contractual terms – but its impact was assumed to be known which it clearly was not. I am not advocating that the investment manager needs to become nanny to the investor but I think disclosure needs to go beyond the familiar generic risks that one sees spouted with such regularity in any prospectus that one might care to pick up.

The business and governance structures too are generally constructed from the managers point of view. Managed accounts are often created to address specific issues – whether it is in relation to ownership and control of assets or transparency to trades. Managers could do much more to protect the interests of investors – but lawyers are remunerated to protect managers – as is so clearly set out in the disclaimers in the prospectus. The obligations in that respect need to be balanced and that can only be done by an independent party making sure that there is a proper balance of interests – which should protect the manager as much as the investor.

Whose interests need protection? Everyone has a stake – the manager its intellectual property and investment edge, the investor its capital, the service provider protection of its profits and reputation. The balance of interests and the protection of interests is very skewed in favour of the manager – that needs to change as it is linked to bringing fairness back into the balance without destroying commercial opportunities.

There is no investment house today that does not proclaim its adherence to best practice. Unique selling points gradually blur as everyone claims to adopt practices of virtue – operational due diligence being no exception to such claims. The reality however is quite different – few do so properly whilst many play at the periphery of what should be best practice. This is what makes verifiability so important – whether it is in relation to best execution, due diligence or risk management. If it is possible to verify the claims of an investment house whether through ISO standards, SAS70/FRAG21 reports or independent valuation reviews and where such information is provided to investors – then that would make a significant change to the investment landscape that we currently observe.

Principle based regulation that addresses the roots of the problems that we have experienced in the industry in the last decade would go a long way to rebuilding foundations of trust – but in finding the appropriate balance to encourage the industry to flourish is an opportunity that would be a great pity to miss.

©Jaitly LLP

The Emperor’s new clothes – the myth continues…..

As we come up to the anniversary of the Lehman Bank failure and the purported start of the current economic debacle it is interesting to see what lessons if any have been learnt in the field of asset management. It appears that in some quarters at least the Emperor’s new clothes remain fashionable.

I was interested to read for example about the survey results in FTfm that investors were far more interested in performance rather than standards. It is a familiar bell with resonance in many areas. It is also interesting to see that little has really changed in due diligence methodology since the events of last year.

As a risk manager meeting clients to describe and reassure them about the risk processes used by my team I was always struck by the approach different types of investors took to the concept of risk management.

The private investor would always appear to focus on performance provided there was no immediate risk to capital. My sessions on risk with private clients were invariably short with most of the time being spent on how investment ideas were generated and where the next generators of performance were going to come from.

The institutional client was quite a different animal – here invariably the sense one often got was that the focus was ‘career risk management’. Would you get fired for having invested with a big name? The chances were that losses emanating from an investment in a big name were far safer from a career perspective provided a few boxes could be safely ticked. Talking of boxes – the miracle black box process still has formidable powers of seduction – particularly when a big name is involved. I remember the justification used to override a concern I had on a regulatory fine on a well known firm that eventually failed – that if that was the standard that was to be applied it would be impossible to employ any of the major brokerage firms as they had all at some stage been fined for regulatory infringements.

Of course in defence of the investor is it ever possible to do an effective due diligence review of a big investment house through the process of a meeting lasting a couple of hours? Is there a realistic practical alternative? There are assumptions made on teams, structures, evaluation processes and competence that are almost impossible to verify through the normal meeting process of due diligence in relation to a large organisation. Yet that is the process that continues to be employed in making an assessment and is clearly insufficient.

When I evaluate risk in an organisation my view is that some of the greatest business and operational risks that exist – lurk in large organisations and the impact of these are almost always significant – Barings, Lehman Brothers, Enron to name a few. The smaller failures that occur at the start of the journey towards disaster are easily disguised and the rot that sets in as a consequence are rarely recognised.

Very small organisations have different risks to contend with – based on keyman issues and lack of infrastructural depth – but these are assessable – because size permits it.

This is not to advocate that only medium sized structures are the safest investment vehicles to place your money with although they recommend themselves to being reviewable, having sufficient infrastructure for questions to be raised about practices that may arise or develop and yet being small enough for small failures to have catastrophic consequences for the business thereby creating incentives to implement better more permanent fixes than the papering over that can occur in much larger organisations.

What I do advocate is that there is an optimum size to an asset manager from a risk management perspective and the big names can create myths of reliability around their existence. Some of the most inconsistent service that I have ever received both as an individual and as a professional have been from large well established organisations.

Due diligence requires more verification work throughout the life of an investment and the status quo on process needs to change. It is in this blind faith in the miracle black box process and the grandeur of the large unverifiable organisation that the myth of the Emperor’s new clothes continues to thrive.

©Jaitly LLP

Auditors – watch dogs, bloodhounds or poodles?

The role of the auditor comes under examination each time a scandal emerges – my interest in the subject stems from the issue of auditor liability – what exactly are they responsible for? A source of constant worry for anyone who earns a living from expressing an opinion is that of liability when it becomes clear that the opinion expressed was incorrect or flawed in some respect. It is a worry that an auditor can never walk away from and it is understandable that they would wish to protect themselves – but the balance at present is not right and the limitations of liability that auditors are trying to impose on their clients are not always reasonable.

When I was training to be an accountant the classic debate for discussion on auditing revolved around whether the role of an auditor was that of a watch dog or a bloodhound. My contention is, that in the context of hedge funds at least, the auditor has become neither – perhaps more of a poodle. The investment manager needs to appoint one of the major firms to ensure credibility – that can make it an expensive exercise – sometimes with very little benefit to the investors and actually very little responsibility economically on the part of the auditor.

Auditor liability has been a sensitive subject and governments have found it difficult to resist the pressures to limit the burdens of liability for the auditor. It is a sound principle that where an expert needs to express an opinion – they need to do a sufficient amount of work to satisfy themselves in expressing that opinion. However, economics always comes into play – would a commercial organisation be prepared to pay an open ended bill for an auditors time in satisfying themselves over an opinion – of course not – there is always downward pressure on audit fees – or is all that matters a respectable name expressing an opinion at a commercially acceptable rate?

It is economics that drives some of the problems we face in receiving audit reports in the hedge fund world.

Let us take a hypothetical situation. Lets assume a hedge fund with assets of say $500m needs an audit and that the going rate for a straightforward audit by a major auditing firm is say $50,000. Let us also assume that this fund is domiciled in the Cayman Islands but administered in another jurisdiction e.g. Ireland, so that the audit work and audit opinion sign off are in different jurisdictions and where the operation of contractual limits of liability may differ. Let us also assume that the audit engagement terms limit liability for the audit to the fee paid for it. The balance of probabilities on a wrong opinion in this scenario lend itself to the audit being staffed with as junior as possible staff (i.e. the cheapest) that would be able to carry out the programme of work as the downside risk even taking into account reputational issues is still extremely low on getting the opinion wrong. What is likely to matter far more to the audit firm, other things being equal, are the economics of retaining the hedge fund as a client to capture the annuity income through reappointment as auditor. In such circumstances the real incentives are neither to be bloodhound nor watch dog but a poodle albeit well trained.

Does this mean that investors in hedge funds get what they pay for? What it means is that investors need to consider very carefully the terms under which their auditors are appointed and they need to pay particular attention to what liability terms have been agreed upon and to whom they report and even where the work will be done and how related firms will apportion work between them. Yes, even major firms have restricted reliance on audit reports and I am aware of a firm that has tried to address the report to the fund’s directors rather than its shareholders which throws open what the purpose of the audit report might be in the first place! The relationship that exists between the auditor and the hedge fund is a contractual one and the parties negotiating the contracts do not necessarily always have at the forefront of their minds in their decision making the likely impact on the investors if things go wrong. The auditor is a necessary appointment but the choice is generally limited to a major name, often with little time being spent on the terms under which they are appointed.

Why is this important? Let us assume that a major fraud with devastating consequences occurs in our hedge fund example, that an auditor conducting their work under acceptable standards should have spotted. In most jurisdictions the contractual terms are likely to prevail – and even if the auditor had been grossly negligent in the conduct of their work there is a real possibility that their liability in this example would be restricted to the $50,000 fee paid. Is that what the investors would have expected when investing in the fund? Almost certainly not – but that may be the reality of the prospect they face. It is what makes it so important for investors to look very carefully at the basis on which auditors are appointed on their funds. Sometimes having a major name as an auditor is not necessarily the panacea that an investor would need.

There needs to be a continuing debate on the role of the auditor – as often the auditor is the only independent entity that has access to the books and records of the vehicles in which investors place their money and there need to be real economic incentives to ensure that the work they perform is to the right standard with people having the requisite experience to reach appropriate conclusions so that they can be watch dogs with bloodhound abilities.

A $50,000 liability in the scenario described is likely to still keep the poodle’s tail wagging.

©Jaitly LLP

Liquidity Management – new fad or back to basics….?

Ever wondered how a fund or a fund of funds manages liquidity?

Offering documents can include an arsenal of provisions for the moment when things go wrong – redemption gates, side pockets, suspension of NAV calculations, suspension of redemptions, revaluation of assets, creation of provisions and reserves, payment of redemptions in specie and the creation of separate classes with differing liquidity.

But these are all cures for the malady once management has to face up to a liquidity problem – what is far more interesting is the approach to prevention.

The spectre of the liquidity axe always hangs in the air – however well managed a fund – because if, for example, you take the case of a fund of funds with quarterly liquidity which only invests in funds with monthly liquidity you still have to manage for the prospect of the fund you wish to redeem from, suspending its normal redemption processes thereby impeding the liquidity flow on your investment. All funds will retain some form of rights and discretion to delay redeeming and paying out to an investor.

The obvious starting point will always be to try to ensure that the liquidity of your vehicle at least matches the liquidity of the underlying investments.

Is this always practical given lock up periods of 6 months to 6 years upon subscription? Some funds will try and cater for this issue by creating lock up periods for their own investment vehicles and by imposing charges for any financing they might need so as not to affect the portfolio as a consequence of a redemption – but that is not so easily done – sometimes because of the push back from the sales personnel linked to selling these funds to investors.

So what are some of the practical things that can be done?

Ensure you have a liquidity profile for your portfolio which shows the time taken and the cash flows for the portfolio to go wholly in to cash by taking into account lock ups in force, notice periods, compulsory gates and any penalty charges that may be imposed
Always maintain a cash buffer to meet ongoing expenses and to meet margin calls – a number of funds faced extreme liquidity constraints in 2008 in the absence of credit facilities because they were not prepared for the Euro/Dollar exchange rate movements for their currency hedges
Ensure that your credit facilities will enable you to meet redemption calls equivalent to the proportion of your longest locked up investment outside the liquidity range of your own investment vehicle.
Avoid investing in investment vehicles or investments that have liquidity mismatches with your investment vehicle.
Ensure that you have given no covenants to your own providers of finance that could place your investments in jeopardy because “they would never happen” – do you know for example what cross default provisions there are in your financing agreements and what percentage reduction in assets triggers a default?

The best liquidity management is done from the perspective of decisions made on the assumption that the fund will need to go wholly into cash and ensuring that any borrowings and requirements for return of capital are properly catered for in the offering documents of your own investment vehicle for such an eventuality.

In order to do it well – assume that the worst will happen – that is the best form of liquidity management.

©Jaitly LLP

The “Expenses” Debate – worth examining?

The current media interest on UK parliamentary expenses is a good moment to take stock of what constitutes a reasonable expense for an investment manager to charge a fund as opposed to a cost that it should bear itself.

I have always found it very interesting to see what an investment manager will charge as an expense to a fund it manages. Practice varies enormously. Some managers will charge bonuses payable to their traders as a fund expense, others research related travel or the costs of information technology and risk management systems.

Received wisdom in the alternatives industry justifies a two tiered fee structure on the basis that the management fee charged – typically on a monthly basis – covers the running costs of the investment manager including staff, systems and premises. The performance fee is the reward that the investment manager receives for generating the risk adjusted returns for which he is appointed.

The fund itself bears its own direct costs such as the costs of trading, audit, service provider fees (including those of the investment manager), direct legal costs and director’s fees.

Soft commissions or bundled commissions are another way for an investment manager and the fund it manages to receive additional benefits that the fund indirectly pays for through the commissions it is charged for trading. These are considered acceptable expenses where the investment manager receives benefits which may for example be research related such as the provision of Bloomberg terminals for the investment manager. The benefits become more nebulous when they relate to travel and accommodation or entertainment. Different regulatory systems may also specify what is permissible or not for investment managers regulated by them.

Where an investment manager starts to charge expenses to the fund that would typically be investment manager costs such as trader bonuses and information technology – it raises a basic philosophic question as to what the management fee is supposed to represent? Is it no longer representative of the investment manager’s running costs or is it to be viewed as a monthly premium for the privilege of having the investment manager manage the fund? Is it reasonable for the investment manager to charge a pure fixed profit element in the form of these fees if running costs are also to be charged to the fund as additional expenses?

Who for example should bear the costs of the investment manager and its staff having to travel to research investment opportunities used for trading the fund’s portfolio? Are these exclusively for the benefit of the fund or are there other clients of the investment manager who receive a free benefit as a consequence? Is it not this very expertise for which the investment manager is appointed and if so are you as an investor paying twice for it?

Investors will often accept the status quo based on the investment manager ‘s success but it is essential that investors understand what they will eventually be picking up the costs for – and whether this was something acceptable or that they were prepared to accept. Success generally keeps these issues at the bottom of the pile.

A careful fund investor should understand the expense profile of the fund. A good investment manager should be able to justify the management fee it charges based on properly budgeted staffing, research costs, premises and systems so that the management fee is what it is described to be – a fee for managing the fund’s portfolio. Where the costs of an investment manager and the management fee it receives begin to diverge – then this should be the catalyst for a review and a discussion between the investment manager and the investors in the fund.

©Jaitly LLP

The “independent” administrator…….

The “independent” administrator……….

As reports come in about the appointment of independent administrators it is perhaps worth adding a note of caution to the panacea that such an appointment suggests. As ever, the devil is in the detail and the appointment of an independent administrator on its own may be insufficient.

Why is that?

The appointment of an independent administrator is an indicator that there may have been a change in mind set by fund managers whether driven by investor demand or by market best practice. That is a good thing – but how good it is, depends on the contractual terms that have been agreed between the administrator and the fund to which it has been appointed. It also depends on the administrator’s experience and infrastructure as to whether the agreed services can be provided to an adequate standard.

It is possible to find independent administrators to funds who in fact provide nothing more than what the industry calls a NAV lite service or who simply provide transfer agency services. There is absolutely nothing wrong in the provision of these services – it is simply important to understand that the service provided is limited to that service alone.

Tread cautiously too where independent valuation services are provided as they may not always be as independent as you might presume.

It is not uncommon to find wording in the offering memoranda of funds where an independent administrator is responsible for verifying the valuations used by the fund to state that where it is not possible to obtain independent verification then the values used will be those provided by the board of directors or the investment manager to the fund. From the administrator’s point of view this is perfectly reasonable and is important in managing their own risks in providing such services to the fund. But where does this leave the investor who believes that the net asset value that they have received from the administrator comprises prices fully verified by the administrator? Because this wording is so common I generally try to insist that an obligation is created whether by side letter or by amending the fund’s documentation that the administrator or the manager is obliged to inform my investor where the net asset value comprises non independently verified prices (or prices provided by the directors and managers) which form say more than 5% of the net asset value. This is essential so that the investor is able to form a better view of the values that comprise the net asset value being reported to them.

It is also not uncommon to find that the contractual terms for the provision of price verification are drafted in such a way that the administrator is protected if they rely on prices provided by the manager or directors of the fund and so there is little obligation contractually to seek out independent verification where current publicly traded price information is not available. When one starts to look at the contractual documentation of a fund – because everyone is so concerned about managing the risks that may attach to them – it is sometimes difficult to see who if anyone is contractually responsible for the valuation of a fund.

Investors need to insist that contractual obligations are created so that there is proper independent verification of prices used for a net asset value – if necessary as ‘agreed upon procedures’ if the uncertainties in valuation are so inherently risky. There is nothing wrong in a fund investing in securities that have inherent uncertainties around their valuation – what is important in such instances is that there is a clear and replicatable set of steps and processes that would enable an independent third party to apply them and reach the same price/value – and that these steps and processes are reviewed and checked as being applied by an independent party.

So what should an investor look for in an independent administrator? Here are some basic questions and issues to consider:

Is the administrator’s business sufficiently diversified so as not to be dependent on the fund manager’s business?
Does the administrator have the capacity and infrastructure to deal with the investment strategies of the fund (don’t necessarily be seduced by a big name – get to know the team that will service the fund – there can be infinite variety between teams) Can they meet the necessary deadlines? Administrators can grow too quickly and lack safe capacity. Does the administrator understand the fund’s strategy and have teams with the requisite experience to deal with it. e.g. appropriate valuation teams?
Does the administrator have robust quality control procedures and a good supervisory and training environment?
Do the contractual arrangements create a real responsibility to provide a “Full Service Net Asset Value and Transfer Agency Service” to the fund and its investors?
Is there a mechanism in place to inform investors if the net asset value includes non independently verified prices over an agreed threshold and whose responsibility is it to report it?
What history does the administrator have with previously reported problems on funds? Is there any litigation that you should be aware of and consider?
Have you done any due diligence on the administrator and the team that will service the fund you are investing in?
Who owns the administrator? Is the administrator able to invest in the funds it services – and does it? Are there any other conflicts of interest that need to be considered?

If you can get suitable comfort on these issues then indeed you will have an independent administrator worthy of that name on the fund you are about to invest in.

©Jaitly LLP

Training in Operational Risk

If you want an investment professional to understand the niceties of operational risk there can be no better training opportunity than to send them to attend a meeting of creditors and investors convened by the liquidator of an offshore fund that has gone wrong.

I attended such a meeting last Thursday. There were a number of things that struck me about it.

Firstly only a handful of investors attended the meeting – some joined the meeting by phone but very few had made arrangements to attend or be represented at the meeting. Was it concerns over publicity, costs – throwing good money after bad, an assessment of the hopelessness of the situation? It is difficult to say.

Meetings of this nature are designed to impart information to those affected by the events in the Fund – and there are significant costs attached to doing so. These costs are inevitable and inevitably they eat into the pot available for recovery. Is there a case to insist on some mechanism such as insurance to cover such eventualities on investments in future?

The nature of the classifications into investor and creditor claims and the priorities given to each type of claim throw into sharp relief what remedies are available to those who stand to lose money from the collapse of such a fund. Who recovers what ahead of whom, where there are funds to distribute to such claimants, can then become significant issues – the difference between getting some recovery or none at all. It also highlights what a fine balance there can sometimes be between a fund being classified as solvent or insolvent based on how a claim may be classified.

Despite the wonderful clarity of vision 20/20 hindsight brings with it – and whether or not there were tell tale signs before the allegations of potential negligence and wrong doing arose – what is instructive about such a meeting is for investment professionals to consider ahead of an investment the sort of things that they may need to deal with in the event an investment of theirs goes wrong…….

What avenues are available to them to recover their investment if things went wrong
Do they really understand how their assets will be held and how they can be dealt with
The nature of claims that could arise and the priority in which they would be paid
The expenses involved in recovering what is left of an investment and who should bear them or whether it is worth paying for insurance to cover such eventualities
What justifications would there be for the investment if the disclosed risks actually came to pass
Can service providers to a fund be properly held to account for their actions or inactions in relation to the fund and to what extent is it reasonable to rely on them in making such an investment.

Where there is fraud – no amount of prior work may necessarily unearth the issues and however good ones risk management – controls can always be overridden. But what is important from a training perspective is to bring home the reality that these things do happen and the only way to emphasise to investment professionals the complications in unravelling such matters is in my view by making them attend these types of meetings – so that they understand first hand what happens when a fund ‘blows up’ and that it is not simply a theoretical risk.

©Jaitly LLP

The Paper Trail

I was at a briefing on Friday – where Insolvency Practitioners were talking about their experiences on the Lehman Administration.

Over the last 9 years I have been warning investment professionals not to ignore the terms which they have signed up to in contracts and pointed out to them the dangers of what they were agreeing to. The response has always been that it was not something to worry about because it would never happen. Lehman has brought home to everyone that not only do these things happen but they have specifically been contemplated for by the lawyers drafting these terms. Accepting these terms has in some instances laid managers open to accusations of dereliction of duty to their investors.

Some in the industry seem to have forgotten that its creation and development was to endeavour towards capital preservation far more than performance. That requires attention to detail and careful consideration of the contractual terms being signed up to. A principle which seems to have been lost along the way by some because of the powerful temptations that performance brought with it. It is only by refocussing on capital preservation with attention being given to the accompanying paperwork that alternatives managers can begin to rebuild the shaken faith of their investors.