Inside some of Australia’s largest investment funds, chief investment officers and portfolio managers are finding it increasingly difficult to implement portfolio decisions without getting a final tick of approval from their back-office colleagues.
The decisive role of operational due diligence in investment manager selection and monitoring is increasing, with leading funds ranking it alongside investment due diligence – or even above it in some cases.
Jonathan Green, who is general manager of investment implementation and operations at the $72 billion New South Wales Treasury Corporation (TCorp), says the fund has a board policy that sits operational and investment due diligence alongside each other.
“We have a board policy that underpins our case and that manages service providers through two lenses – investment and operational due diligence. They are equivalent and both have to be satisfied before a manager can be appointed. In the past 12 months, we have had an instance where the investment case has passed but operational due diligence hasn’t,” he told delegates at the 20th annual Conexus Financial Investment Operations Conference in Sydney on Tuesday.
“We have a set of things we look for as base information, such as a separate chief risk officer to the chief investment officer. In this we try to systemise it as much as we can, and get baseline information. We operate a T+1 cycle. If a manager can’t provide us with data in that time frame, then it’s an outlier,” Green continued. “This is not about the one-off looking under the hood, but the ongoing management of it.”
TCorp has explicit and implicit elements to its operational due diligence, with a sound governance framework. It aims to capture data and systematically harness it.
“Operational due diligence supports the delivery of investment returns; you can’t have one without the other,” he said. “Whether you’re regulated by APRA or not, it’s a function of best practice.”
A more balanced approach
Tricia Nguyen, who is principal and operational due diligence lead at Mercer said ongoing regulatory maintenance means more awareness of the impact of operational risks on returns for funds.
In the past, manager selection was more focused on alpha and performance, now there is more of a balance with operational risk, Nguyen said. Mercer has undertaken more than 1000 operational due diligence tasks.
Lounarda David, who is chief investment operations manager at Sunsuper and was one of two recipients of a Lifetime Achievement Award at the conference for her 30 years of service to investment operations, said that at Sunsuper, operational due diligence doesn’t sit alongside investments, it sits on top of it.
“It’s the last sign off,” David said. “We ask, ‘Is there any reason for the manager not to be appointed?’ We’ve had situations, more often recently, where we haven’t been able to pass operational due diligence. The whole purpose is not to stop and criticise a manager, but to understand the risk of the mandate, and to set up ways to collect data so that risk is quantified and managed on an ongoing basis.”
Sunsuper has more than 100 fund manager relationships, and places a high value on operational due diligence. David said it’s important to set up a process that’s smart and efficient.
“You have to know what are you looking for and why,” she explained. “It’s about the right information and making the right assessment. [That way] the level of data you may need may not be as horrific as [it would be] if you asked for everything.
“Our aim is to help the manager get over the line if they are able. If they are a long way from minimum requirement, we are very candid and tell them if they want to manage our money they’ll have to, for example, set up independent boards.
“The bar is rising for us and it’s rising for everyone who works with us; we are pushing the managers to get to that level.”
“It’s about the ongoing work,” David continued. “On the investment side, it’s easy to identify if the manager is not performing. On the operational side, this might not be as obvious. So it is important that we provide an annual report to the audit committee on all the due diligence we’ve done or not done. It is pretty high on the agenda of our board.
Better understanding of risk
“If you buy an expensive car and don’t take comprehensive insurance, there’s something wrong. We are giving our members’ money to managers to manage. This is not an insurance but it gives you an extra layer of protection or comfort, that’s good for our board and for our members. We don’t want to be on the front page of any magazine or paper, or be associated with any managers that have any compromised processes or people or technology.”
The panel, which also included Emma Robertson, head of operations at Vision Super, said operational due diligence gives a fund a better understanding of risks and how to manage them. It also gives a close up view of the managers’ operational processes and how they might fit with those of the fund.
David said: “Ultimately, the fund [must] make sure it is comfortable with the risk, not with the manager. The scoping is to satisfy the fund not the manager. We look at it as more than just compliance, understanding risk and being OK with it. We are looking for the gaps in their operating model that might create problems for us.”
There are certain things that can’t be quantified, such as culture. The panel agreed that good due diligence includes time in the office of managers. It requires judgement and experience.
Jo Leaper, manager of operational consulting at JANA, who chaired the panel, said it also requires knowledge of accounting, legal, tax, and audit.
“You need very far-reaching skills,” she said.