Safeguard against Fidentia
September 17, 2007, Gerald Saacks
New hedge fund rules may require health warnings
Certified financial analysts are preferable to a former sportsman or university dropout
GERALD SAACKS
The Fidentia debacle has hopefully woken up the somewhat complacent and incestuous retirement fund industry. Fidentia will one day become a corporate governance case study. By asking basic questions, prospective clients would have been alerted to a pitiable internal control framework.
Trustees act as the gatekeepers of pension money. It is crucial that they are independent from service providers, ask the right questions and understand the answers. The investment world is complex and fast changing, and has a dictionary of jargon to confuse and intimidate.
Here are some preliminary questions trustees should ask:
Where will our money be invested? No money should be put into a fund manager’s back account, but rather in Financial Services Board (FSB) regulated vehicles such as nominee firms or unit trusts. Other unregulated trusts must be avoided, especially if a trustee is a director of the investment manager;
Is the fund manager FSB approved? Fidentia had no approval to manage equities;
What are the qualifications and experience of key staff?
Certified financial analysts (CFAs) are preferable to a formers sportsman or university dropout. Segregation of functions is a basic internal control. It is vital that those making decisions be different to those doing the accounting and the custodians of the investment scrip. Independent reconciliations of investment scrip to client reports would have picked up missing money and misleading client data;
Is the proposed investment mandate suitable for your fund’s needs for liquidity and required investment returns?
Is the strategy compatible with the funds’ risk profile? Putting money required for monthly payments top orphans into illiquid property and private equity is not wise. Prudent investment guidelines suggest that fore an average fund with a long-term time horizon, not more than 10 percent be placed into property or private equity;
How regular are these independent valuations done?
Who are the fund manager’s external auditors? Auditing an investment house is different to auditing a corner cafe; and
When was the last audit done? Fidentia’s last audited financials are from February 2004. Well-run firms should not take more than three months after the end of the year to produce audited financials.
Auditors focus on auditing a firm itself, they do not look a the individual funds managed by the firm, nor investment performance. Because of the games played with performance, the CFA Institute has developed the Global Investment Performance Standards (Gips).
Although a firm can follow Gips, it is preferable to have this verified externally, Gips verifiers would easily have found missing scrip, fictitious reporting of client assets and major mandate breaches.
According to the FSB report, Fidentia used poorly drafted legal contracts for option contracts it entered into on behalf of clients. It is crucial that a firm has competent legal advisers and a qualified compliance officer. Only once trustees have done a health check on a prospective investment manager should they look at other criteria such as the robustness of the process and repeatability of the returns. Past returns could be based on luck, or even simulated, which is outlawed by Gips.