Investments

Supertanker funds and liquidity

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Dear Fund Director,

I have found this article about the liquidity risk in supertanker funds.

I think Mr. Beckett opinion is worthy to be considered when we follow up our funds and the funds where we are invested.

Taken directly from the article find interesting paragraph:

Using the AIFMD as a template we can start to ask specific due diligence questions to assess the liquidity risk of big funds such as:

  1. Outline any illiquid, non-daily priced or low volume assets held and how you manage these positions (eg direct property, unlisted stocks).
  2. What is the maximum size (capacity) of your strategy?
  3. Have you stress-tested the current portfolio, the liquidity profile of your investors or subjected the strategy to liquidity scenarios?
  4. What is the maximum percentage of the fund’s assets held by a single client and the ratio of retail to institutional clients?
  5. What has been the largest weekly and monthly outflow from your fund and what percentage of the fund did this constitute?
  6. Indicate your current liquidity ladder at normal prevailing prices – how much of the fund you can liquidate in one day, two days, seven days, 30 days, 90 days.
  7. Are there any sub-sectors where you own more than 10% of that market? Also detail the smallest market and holding (market capitalisation) you are prepared to hold.
  8. What redemption policies (eg unit cancellation, equalisation, dilution levy, swing-pricing) can you currently employ?
  9. Provide details of the liquidity of your portfolio, including the type of cash instruments held, trading liquidity of other assets and how quickly 75% of the portfolio can be traded out.
  10. Highlight and describe any holdings held currently (or previously) in the following: Gold bullion, Commodities, Exchange traded commodities, Traded endowment plans, Milk quotas, Contracts for differences, Direct property, Infrastructure, Cash held for margin requirements, Complex derivatives (eg OTC, non-vanilla Swaps, Swaptions), Unlisted securities (inc private equity, private loans).

I hope this helps.

Yours faithfully ,

The Indeep Fund Director

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Liquidating a fund

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Dear Fund Director,

If you are liquidating a fund which was under your mandate, you are not alone. Fund industry has its own trends and fashions. And trends and fashions have always a maturity date.

Last week we were informed about the end of the Goldman Sachs BRIC fund. The fund was swallowed up by the GS Emerging Markets Equity Fund. The underlying cause was that the BRIC acronym is not in vogue any longer but formally GS stated reasons were to “optimize” its assets and “eliminate overlapping products”.

Indeepfd - BRIC fund liquidation

(Source: Bloomberg)

This story can also happen to us. Some reasons to liquidate a fund could be:

  • The fund assets are low, we couldn’t reach our asset expectations 3 years after launch.
  • The fund assets are low, the asset class is no longer in fashion.
  • The fund performance was poor in comparison to the benchmark.
  • The fund manager was an “investment star” and decided to leave the company. Then we faced big redemption flows.
  • The fund is doing something very similar to another of our funds. In the end, we are duplicating the strategy and confusing the investors.
  • The investment strategy didn’t work as it was supposed to.

However, in all this cases please think about a nice wording when you inform the regulator and your investors. GS did it very well.

If possible, also as GS did, try to merge the fund you would like to liquidate with another company fund with a similar investment strategy and risk profile and inform properly your investors about the new fund (however, you should sportsmanslikely accept losing part of the investors during or just after the change).

Remember: 1 – Merging sounds much better than liquidating, specially in the headlines. 2 – Offering investors a solution is always better than simply kick them out. 3 – Cash is also a solution. In some cases, probably the best.

I hope this GS example helps you with your next fund “liquidation”.

Yours faithfully,

The Indeep Fund Director

 

Markets plunge: contact the fund manager

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Dear Fund Director,

The markets are plunging. It is the 4th business day in a row they are in panic. Losses in the main equity indexes are relevant. Most probably the funds with equity exposure, no matter which region, may be suffering. Probably now is a good time to know what the fund managers think about the short a mid-term markets evolution and which actions they are going to carry out. These questions are useful to gather different market views, to let know the fund managers that you are following their funds and to protect yourself in case things go extremely worse.

Remind that your role as a fund director is to monitor all areas of activity for the funds under your mandate. Moreover, to ensure that your controls are traceable can be extremely useful in case of the regulator or auditors ask you for evidence of this control.

In the meantime, find an El-Erian’s article which can give you some good arguments for your coming conversations.

sg2015082449320

Yours faithfully,

The Indeep Fund Director

Chinese shake

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Dear Fund Director,

Just in case the Greek turmoil headlines are hiding some other matters in current financial markets, I would like to inform you about the big sell-off in the Chinese stock market, about -20% in the last 5 days, and propose some questions you may pose to your managers.

According to data compiled by Bloomberg, almost 200 stocks halted trading after the close on Monday, bringing the total number of suspensions to 745, or 26 percent of listed firms on mainland exchanges. Most of the halts are by companies listed in Shenzhen, which is dominated by smaller businesses.

In this sense, I would suggest that you gather information about the impact in the funds under your mandate in 4 ways:

1 – Which is the exposure of the funds to these markets?

2 – Which has been the impact on performance due to these stocks during these last days (weeks, months)?

3 – In which way will the suspension of trading in terms of fund valuation be handled?

4 – What is the fund manager’s opinion on this matter and what is he planning to do in each scenario?

Having said that, find below an interesting chart and link to Bloomberg on the rise and fall of China’s Equity Market and the policies carried out during these last months for a better understanding to the matter.

china

Yours faithfully,
The Indeep Fund Director

4 key controls to follow as a Fund Director for a Synthetic ETF

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Dear Fund Director,

It is not very common to be a Fund Director of an ETF however, some of you may be in this position now or in the future. In this case, I would like to introduce to you 4 key elements which you should follow closely during your mandate:

1 –  Counterparty risk. The synthetic ETF’s are based on the fact that there is a Swap agreement with a counterpart which is the main driver of performance tracking with the index we intend to follow. See this explanatory document by Vanguard. In this sense, following counterparty risk is key in these funds specially in case of UCITS, where UCITS Directive states that the risk exposure to a counterparty in an OTC derivative transaction shall not exceed 5% of the assets of UCITS, or 10% when the counterparty is a credit institution. Apart from that, there is the EMIR issue that will be developed in next posts. In this sense, it may be worthwhile to pose questions to the risk managers about this issue.

2 – Tracking error. Tracking error is a measure of how closely an ETF follows the index to which it is benchmarked. As this is key for investors looking for Beta, there are public comparisons. It can be a good idea to ask the investment managers which is our historical tracking error for our ETFs.

3 – Costs. Sources of cost may vary: transaction costs, management fees, swap costs. However we must ensure that our ETFs are competitive. What about asking our business developers about the costs of our competitors? Be sure that our potential investors will check this as well.

4 – Liquidity. Investors like liquidity, specially in these days of volatility. Usually asset managers appoint market makers which ensure liquidity and a narrow bid-ask spread. Posing questions on how good our ETFs are ranked in comparison to our competitors with regards to the bid-ask spread will be a good measure to know if our market maker providers are performing well.

I hope this helps.

Yours faithfully,

The Indeep Fund Director.

Value investing approach: Buffett lessons

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Dear Fund Director,

Most likely at least one of the funds under your directorship mandate may be managed by a fund manager following a value investing approach.

Value investing is an investment philosophy that evolved based on the ideas that Ben Graham and David Dodd started teaching at Columbia Business School in 1928. There are many interpretations of what value investing is, but the basic concept is as follows: essentially you want to buy stocks at a discount to their intrinsic value. Intrinsic value is calculated by taking a discount to future cash flows. If the stock price of a company is lower than the intrinsic value by a “margin of safety” (normally ~30% of intrinsic value), then the company is undervalued and worth investing in. Generally, value stocks are companies that are in decline but the market has overreacted to their situation and the stock is trading lower than their intrinsic value.

buffet cnbc

I hope that after listening to the whole or part of the video above, you may have some valuable questions to pose to the fund managers following this approach.

Yours faithfully,
The Indeep Fund Director.

Turnover Rate: ¿angel or devil?

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Dear Fund Director,

Historically, the turnover rate has been a double edge sword. Fund managers were afraid of it because it meant more cost (and less performance), while financial executives tended to like it because it was seen during several decades as the milky cow of the group. In my opinion, regulation was soft at that time when TER ratios were promoted and did not include the impact of brokerage fees in the ratio. However, Mifid II tried to correct it kind of successfully. Find below the evolution of this ratio, which is showing a decrease in these last years.

Having said that, some investment strategies and asset classes require higher turnover rates. The size of the fund matters as well, given the difficulty of rolling big positions in some funds with huge assets under management.

A high turnover rate should not be considered as a negative element for itself. It may show that the fund manager is active and in this case, if this higher activity means higher returns and lower volatility for the fund, then it could be more than welcome. On the other side, if fund performance is average or poor, drawdowns are not reduced and volatility is average within their asset class, you should really ask the fund manager to explain why the figures are so high?

Yours faithfully,
The Indeep Fund Director

turnover