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

Hedge Fund new investment strategies

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Dear Fund Director,

Interesting video about new investment strategies carried out by Hedge Fund managers.

bloomberg hedge funds

Yours faithfully,

The Indeep Fund Director

NAV calculation errors review

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Dear Fund Director,

Have you checked NAV calculation errors in your funds during these first six months? Probably no fund has got a NAV calculation error over the regulatory or internal thresholds. These thresholds may vary depending on the jurisdiction and the administration company. Generally, management companies’ thresholds tend to be much less high tolerance than the regulatory ones. Make sure you have the latest version of material impact for each of the funds. For example in Luxembourg for each of these types of UCIs the tolerance threshold is specified hereunder:

money market UCIs/cash funds: 0.25% of NAV

bond UCIs: 0.50% of NAV

shares and other financial assets’ UCIs: 1.00% of NAV

mixed UCIs: 0.50% of NAV

It could be interesting to analyze which of your funds have been the ones with more NAV calculation errors and the causes. To improve this area of risk will diminish a lot the liability risk of the Management Company and the Board of Directors.

Ensure also that the internal procedures to be followed once a material impact has been detected are clear and in compliance with the latest regulations.

Yours faithfully,

The Indeep Fund Director

Graccident or Greek fright

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Dear Fund Director,

Yes, the markets in Europe fell more than 4% today due to the new episode of the Greek crisis. Last week they jumped more than 5%. Volatility has increased recently a cause this matter. We have seen thousand of headlines in the front pages of all newspapers, as Mr. El-Erian shares in this post in FT.

I hope you have already posed some questions on the impact of this matter on the funds. Otherwise, I would suggest to question the fund managers the impact so far, as well as their views and investment strategy for each of the future scenarios. Remember that it is not only an equity market related issue but it has also consequences in the EUR and the evolution of the European governmental fixed income.

Yours faithfully,

The Indeep Fund Director