THIS REPORT IS SPONSORED BY J.P. MORGAN | Managing market exposure, interest rates, and foreign currencies is par for the course for institutional investors. The world’s best investors also recognise that managing operational risk is just as important.
“Every fund now has an operational due diligence (ODD) process,” according to Tony Kenna, head of funds services, Australia & New Zealand. “While the industry is finding it challenging and costly (given there is no risk premium attached to the undertaking), there’s no longer a discussion of ‘why’ but ‘how’.”
“It is important for asset owners to partner with organisations that are committed to supporting investors on this ongoing transformation journey,” Kenna says.
A thorough ODD process assesses how fund managers deal with risks related to: not being able to process transactions; errors regarding trade execution, settlement or valuation; compliance with relevant laws and regulations; and service provider issues or general disruptive events.
J.P. Morgan, which has a deep understanding of end-to-end risk and control frameworks, recently spoke to Telstra Super about its ODD approach.
TelstraSuper head of business intelligence and investment operations, Miles Mallick, said that not every manager passes its ODD screen. “
The vast majority pass but we have had occasions where we have told our investment team that the manager is not investible due to certain issues,” Mallick says.
TelstraSuper ODD lead Martin McCabe says the fund has also had success changing fund managers’ operational practices for the better.
“There have been situations where we feel managers’ practices aren’t up to our standards so we’ve asked them to change. So far, managers on the whole have been quite receptive to that.”
TelstraSuper, with the assistance of ODD consultants, has already assessed alternative managers (hedge funds, private markets) and traditional asset classes.
“It would be very difficult for us to visit all of these global managers and have face-to-face discussions on operational processes, risk culture, etc.” Mallick says. “We have found that consultants are best placed to conduct the reviews, given their resourcing and experience.”
However, the consultant’s ODD report is just a starting point for the fund, McCabe says.
“These assessments can be a rather qualitative landscape and we’re trying to add a quantitative framework,” he explains. “We have drawn up risk management parameters as part of the ODD framework to help keep it transparent so that as our investment team is assessing a potential manager it can also run them against the key ODD criteria.”
TelstraSuper applies a minimum standard to all managers but boutique managers are not necessarily expected to match the resources of larger organisations.
“Through experience, we’ve gained a good feel as to what industry best practices are within areas such as systems, processes, procedures, policies, third-party providers,” Mallick says. “That differs from region-to-region and also asset class-to-asset class.”
The Australian Institute of Superannuation Trustees (AIST) has proposed a collaborative approach where managers pay for their own assessment to lower costs. While it raises an inherent conflict of interest, the proposal has found support.
McCabe says TelstraSuper supports the AIST proposal, which would save funds time and help drive a standardised ODD approach – but the fund would always do its own deeper dive.
“If we were using a report that the manager has paid for, we certainly wouldn’t use that as all of our ODD work and file that away,” he says. “We would review that as a starting point and then ask our own consultants to do further independent analysis if we felt it appropriate.”
J.P. Morgan would like to thank TelstraSuper’s Miles Mallick and Martin McCabe for sharing their thoughts on ODD. For more information on how J.P. Morgan is working with the asset owner community, please visit: jpmorgan.com/is