Investment Due Diligence

Transcription

1 Investment Due Diligence by John Caslin and Richard Gallagher 13 February 2018

2 Disclaimer The views expressed in this presentation are those of the presenters and not necessarily of the Society of Actuaries in Ireland 2

3 Summary Contents Agenda Assumptions Why do Investment DD? Initial DD Phase Investment Strategy Systematic Trading Strategies Index Tracking Funds Cybersecurity Derivatives Risk Mitigation Credit Risk Management RG JC RG JC Conclusion

4 Agenda Why do due diligence? Agenda Assumptions Key points

5 Assumptions Access to investment services Segregated account Collective investment vehicle (CIV) Depth of due diligence Deep dive for higher risk strategies Less intensive approach for lower risk cases Analysis of past performance Subject of an earlier paper by John Caslin entitled Hedge Funds 5

6 Why do investment due diligence? 3 Modest Aims Detect Fraud Ensure Good Fit Reduce Probability Of Material Flaws 6

7 Why do investment due diligence? Legislative Requirements Insurance company Pension fund MiFID firm Article 132 Solvency II Directive Occupational Pension Schemes (Investment) Regulations 2006 MiFID Directive & MiFID Regulation 7

8 Initial Due Diligence Phase Documentation Information Conveyed Preparation of Due Diligence Questionnaire 8

9 Documentation Prospectus Annual Reports & Filings Marketing Materials Objectives, service providers, strict liability of depository, and segregation of asset management & NAV calculation Audit, list of investments, fees, and related parties More details on current investment strategy KIID Information on calendar year performances and fees DDQ Questions posed, quality of responses, and transparency regarding key risks 9

10 Investment Strategy Objective Instruments Time Horizon Entry Triggers Exit Triggers 10

11 Investment Strategy Risk Management Diversification Target risk level Unfavourable and Favourable Market Conditions 11

12 Sharpe ratio Investment Strategy Correlation to Existing Portfolio Capacity Constraints Reducing returns [Sharpe Ratio] NS > [Sharpe Ratio] EP *ρ (NS,EP) 12

13 Example Systematic Trading Strategies P(at least one significant result) = 1 P(no significant results) = 1 (1 0.05)^20 = 0.64 Type 1 Error Particularly prevalent at undemanding significance levels 13

14 Systematic Trading Strategies Data and Model Issues Data cleaning Model complexity 14

15 Systematic Trading Strategies Out-of-Sample Testing - Cross Validation Training sample Test sample Error measurement Cycle through dataset 15 Model Training Data Test Data

16 Index Tracking Funds HSBC UK Survey 1 90% questioned invest in passive funds 30% no special due diligence Focus on Replication Method Full physical replication Physical stratified sampling Using derivatives 16 1 Importance of Due Diligence for Index Tracker Funds HSBC GAM, 2015

17 Index Tracking Funds Tracking Difference Error Tax Domicile Risk Management Fund Benchmark Cash flows Currency Securities lending Benchmark 17

18 Cyber Security Cyber Security Gemalto Breach Level Index 2015/16 Cyber Fraud in a Digital Age UCC Conference Jan Firm wide area of focus Robust procedures & controls Regular review & testing for existing / emerging threats People to meet at on-site Information technology & physical environments Independent Validation: ISO and Third party consultation 18

19 Derivatives Market Risk Daily mark-to-market Stress testing Cash flow forecasting VaR and C-VaR measures Counterparty Risk Current exposure Potential exposure 19

20 Credit Risk Management Debt securities Counterparties 20

21 Credit risk Credit analysts & jurisdiction 25% probability credit research analysts will make an incorrect judgement Loss given default for a Chilean counterparty is assumed to be 50% CHILE Limit the impact of default to 0.25% of the NAV Maximum exposure o Chilean counterparty: 2% of NAV 21

22 UCITS Counterparty Risk Diversification of credit risk o Exposure limits a function of counterparty and instrument o Highest limit: 20% of NAV o Limit applies to a group of counterparties under common control o Exposures that don t count o Exchange traded derivatives o Omnibus v Segregated account Bank 20% AB plc Futures Broker 30% 22

23 23 Credit Risk Monitoring

24 Conclusion Why do due diligence? Vehicle, service providers, & people Investment Strategy Specific issues Risk issues Paper 24

25 Thank you for your attention Investment Due Diligence by John Caslin & Richard Gallagher