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Business and operational management insights for
multi-manager investors, clients and service providers
Newsletter 3
Welcome to the April 2009 newsletter! If you thought unlisted assets had received enough attention of late, well think again. The latest letter to trustees from APRA provides yet another viewpoint. And before you update your unlisted asset valuation policy, I encourage you to take a moment to think more broadly about this issue by reading this month’s newsletter.
I hope you enjoy the newsletter, and we look forward to your feedback.
Best regards
Brett Elvish
Financial Viewpoint
04 1317 6164
brett@financialviewpoint.com.au
Unlisted valuations: Real lessons or distraction?
Trustees have just received APRA’s latest letter Valuation of unlisted assets – General principles for trustees. After a quick read, the letter is passed to the CEO for review, with an update to be prepared for the next board meeting. The CEO reviews and updates the unlisted asset valuation policy and checks to make sure that the fund is not engaged in APRA’s “examples of unacceptable valuation policies”. A short paper is prepared for the board, along with an updated unlisted asset valuation policy for their approval. The board reviews the policy and congratulates management on a job well done! Everyone is happy, right. WRONG!
Whilst the global financial crisis has been far from an enjoyable experience, it has provided many lessons. One of the biggest lessons from the past year is:
Don’t just react. Stop, think, think some more, then act.
There is an excessive amount of noise at the moment making it difficult to differentiate between the real lessons from this crisis and the persistent distractions. Noise is coming from all directions; markets, media, members, managers, regulators and the ratings houses.
A different way of thinking about APRA’s latest communication to trustees?
The first step is to dispose of the word “unlisted”...it is purely a distraction, which in the current environment is generating many emotional and unhelpful reactions. Whilst unlisted assets (generally classified as alternative assets), have particular issues and complexities, it is a subsidiary issue. Even at a micro level, the focus on alternative assets is not helpful. Having had the pleasure of transitioning large portfolios of assets during the credit crises, traditional assets (e.g. cash and bonds) can at times have many of the problems of alternative assets e.g. infrequent trading, model driven prices, etc, and therefore present similar valuation problems. However, let’s get back to broader valuation considerations.
Firstly, why is valuation important?
Ultimately, the valuation supports the apportionment of entitlements between members, and this is its most important function. And in this regard, it is primarily of real relevance when cash is entering or exiting an investment option via new contributions, switches, pension payments or an exit from the fund. Thus, its primary importance is around equity between members.
Strategy always comes first
However, before the board flicks the letter to management for its review, there are a range of strategic choices and decisions that have been made by the board that impact upon various business and operational practices, and ultimately valuation policies. For example, strategic choices may have been made such as:
- Pursuit of better long term returns for members by investing in unlisted and less liquid assets
- Keeping costs low to provide better retirement outcomes for members
At this time, the board should ask itself whether these strategic choices are consistent with its offer to members and the fund’s operating model:
- Is the liquidity you offer members consistent with the liquidity of your assets?
- Is the certainty of valuation (e.g. daily pricing and switching) consistent with the imprecision in your underlying valuations?
- Is the frequency of pricing and switching consistent with keeping costs low?
- Is the number of investment options offered consistent with keeping costs low?
So take a moment to think first in terms of strategic choices and your supporting operating model, before getting into the detailed consideration of unlisted asset valuation policies. And, acknowledge that your positioning requires trade-offs and you cannot be all things to all people.
Beyond member entitlements
When getting into the detail, whilst member entitlements and equity should be your primary concern when considering valuation issues, there are a myriad of business and operational risk management considerations as well. Let’s consider conflicts of interest as just one such issue.
Principal-agent problem
Whilst the industry prides itself on its representative model, it doesn’t make the industry devoid of agency issues, and self interest is a basic human instinct. Conflicts are still present and need to be managed, and valuation and associated investment performance are areas of potential conflict. Consider the following self interests associated with investment performance and therefore valuation:
- Board members have their reputations and roles at risk
- Management have their jobs and bonuses on the line
- Investment managers have their mandates at risk
Whilst you may feel that you are well protected, poor or fraudulent valuation practices have been a common thread on some major disasters. For those that have been in the industry for a while, you will probably remember the Morgan Grenfell Peter Young affair. At its heart was self interest and manipulation of unlisted asset valuations.
There are many other considerations beyond the principal-agent problem. Click here for a list of some broader considerations associated with valuations.
Summary Viewpoint
So before you flick APRA’s letter to management to update your unlisted asset valuation policy, I encourage you to:
- Stop and think...is there broader lessons out of the noise associated with unlisted assets?
- Think strategically first...what are your strategic choices and are they appropriate?
- Think more broadly than valuation...there are many inter-related issues that require consideration
- Don’t focus purely on unlisted alternative assets...focus on valuation in a holistic sense
Valuations: Broader considerations
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