Financial Times Guide to Investing in Funds

The future of the fund industry’s service providers and advisors to investors 195

It is also worth noting the view of Steven Brown, Professor of Finance

at New York University on this. In an interview on Opalesque TV in

February 2012, he noted that operational due diligence should feature

as a form of ‘alpha creation’ and that costs for independent due dili-

gence should be about $15,000 which is not so expensive for the value

he deems it will add to fund selection.

2

The future of the fund industry’s service

providers and advisors to investors

In the meantime the big question is: who can an investor trust? This

concerns all of the actors involved in the financial industry, from large

banks to smaller institutions, rating agencies to consultants, advisors

and managers. Many of these financial leaders, including some very

good ones, got caught up with the wave of failure that stigmatised the

2008 crisis by not thoroughly checking their facts and not doing their

jobs properly. In the end that led to direct or indirect misrepresenta-

tions. It also led very often to ignoring the best interest of investors.

What made things worse is that, for the most part, losses were borne

by the investors but not their professional bankers or managers who in

the end either kept what had been earned already or if not, nonetheless

benefited from the governments’ bail outs paid for by the taxpayer.

Fund service providers

Service providers will find it hard to justify the reliability of their work

in the years ahead unless some fundamental issues are addressed and

standards unified globally. There are still too many conflicts in the

financial industry in the way it operates to make the provision of serv-

ices impartial. The desire to see investors being better protected has

been the catalyst behind much government action world-wide for many

years, but a lack of practical understanding and a desire to limit costs on

the industry has meant that some important opportunities to improve

standards may have been missed. What is happening following 2008 is

that we are seeing a shift from the trust that bound financial advisors

and bankers with their clients, to the less personal but perhaps more

2

http://www.opalesque.tv/hedge-fund-videos/Stephen_Brown/1

196 11

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Conclusion

reliable government backed UCITS or equivalent fund set up which is

now trumpeted as a standard for investor protection.

As discussed in Chapter 5, however, I do not think enough is done to

secure the role of the independent third party administrat ors even in

EU regulated UCITS. This would have been essential to ensure fair pric-

ing, especially where funds use hard-to-value assets and this includes

some of the derivatives used by UCITS. The need for independence

grows in my view with the complexity of the underlying investments.

Ideally, as part of the financial industry’s processes, with the back-

ing of a stronger legal framework, the administrator should be

working with the manager to set standards when dealing with the

valuation of hard-to-value assets. This process should be fully dis-

closed to the public, with the ability to verify it by accessing existing

records proving that the valuation process is followed. There has been

an increasing trend for institutional investors to request internal pric-

ing policies, especially for level 2 and level 3 types of instruments.

However on this point, new laws have not been very effective.

In a similar vein, although custodians are also part of the complex

new regulations, in Europe at least, it is not clear what their role is in

verifying the existence of assets. Many banks work with other banks

and traditionally the ownership of assets is not always clearly pre-

scribed in legal form. This has left an industry behind the times, where

electronic trading and reconciliation systems are often too complex

to be properly implemented and followed. Again, this is an area that

is hard to penetrate for any regulator, and most have instead targeted

the need for a higher capital base in financial institutions that control

client money and assets.

Consultants

Consultancy firms have been an active provider of services to investors,

traditionally acting in connection with pension funds but also more

and more with other financial institutions. Their role is very varied, but

generally it is to advise their clients on how they should invest their

money in relation to their global holdings and to meet potential future

liabilities. For example, they might provide a list of preferred funds that

they deem to be good for returns in the context of the client’s global