Asset Management COVID-19 risks update

In these volatile markets asset managers now, perhaps more than ever, are facing increasingly complex and urgent decisions going to the management and content of portfolios. Whether that be in reaction to market movements, investor redemptions, emerging opportunities and changing regulatory considerations, or as a result of proactive moves designed to get ahead of what may be around the corner, there are difficult decisions to be made by managers across fund types, strategies and sizes.

Every decision has its own challenges and turns on specific facts and background context, but what is becoming increasingly apparent in current markets is that, from a contentious risk perspective, there are two categories of decision that we now seeing arise frequently and some core considerations that are central to getting each of those decisions right; the rebalancing of portfolios and the valuation and pricing of portfolios. The considerations relevant to these decisions are nothing ground breaking and not points managers haven’t looked at many times before – but nevertheless they are points that if placed at the centre of the decision making process will mean managers don’t go too far wrong in even the most complex of scenarios.

Disposal of assets

From what we are seeing questions going to the composition of portfolios in these volatile markets fall into two camps; straight investment decisions and decisions aimed at managing risk, be that regulatory risk, risks associated with breaching thresholds and limits or the risks that can come with investor redemptions. On the risk management side of the decision making process, the considerations set out below feature prominently in every decision being made:

Is it in the best interests of investors? – in many ways this goes without saying and any portfolio management decisions taken that can’t satisfactorily meet this test will face serious scrutiny. However, drilling down into the analysis it is helpful to consider the competing factors that feed into a determination of whether any given decision is in the best interests of investors. Where assets are held across multiple funds, it is important that the interests of investors in each individual fund are considered. Where any conflicts might arise between the interests of the asset management firm and the interests of investors, those potential conflicts need to be recognised and the decision making process followed in resolving them documented. Where assets are being sold to manage portfolio risk, managers should make sure that the impact of the sale on investors in different positions (eg redeeming, subscribing and remaining) has been considered and any potential disparity between investors interests effectively managed.

Valuation and pricing

As markets move, portfolios are rebalanced and investors redeem, there is a risk that calculated NAV can quickly become stale and potentially result in the unequal treatment of investors. The need to treat investors fairly should be the overriding consideration in reaching valuation decisions in a fast moving market. It is important to recognise the benefits of ensuring consistency with historic valuation practices and implemented policies and procedures, and adhere to those where possible, but also the need to be thinking about whether changes to the typical way of doing things need to be considered in light of the volatility being experienced. Do prices need to be adjusted to prevent a first mover advantage for redeeming investors? Does revaluation need to be undertaken more frequently than might usually be the case? There is not always an obvious answer, but decisions of course have to be made and managers will be well served by recognising and documenting the decision making challenges faced and being able to demonstrate at a later date that whatever the decision reached, the protection of investors was at the heart of the process.

The importance of decisions going to the disposal of assets and the valuation and pricing of portfolios is already becoming abundantly clear and will continue for some time. At the time of writing we are already seeing financial headlines concerning the suspension of property funds arising from liquidity issues caused by investor redemptions, the difficulty of disposing of illiquid assets and the challenges faced in valuing those property assets in these markets. We are also seeing pricing dislocation between NAV and the closing price of ETFs at a level that has not been seen in the recent past. The challenges these volatile markets pose will remain and cannot be eradicated, but managers can deal effectively with the risks posed by these challenges by keeping the best interests and fair treatment of investors front and centre of their decision making processes.