PALM DESERT, CALIF.—As investors have fled equity funds, the industry’s move into alternative investments has become one of the biggest concerns of directors of the board.
“Inflation-protected, dynamic allocation, tactical funds—all are loaded up with derivatives and incredibly complicated instruments,” noted Gary Moody, an independent director at AllianceBernstein, speaking at the “Board Perspectives” panel at the Investment Company Institute’s Tax and Accounting Conference here Tuesday.
“And who is on the front line but the auditors and the boards?” asked Moody, who called the potential implosion of alternative products “the perfect storm.”
The best way for directors to wrap their brains around derivatives and other complex securities—and to ensure that funds’ daily net asset valuations are accurate—is to have sound valuation and pricing procedures, said Glenn O’Flaherty, an independent director at Aquila Investment Management.
“You need good data, policies, procedures, controls and reviews to get there,” O’Flaherty said.
But remember, he cautioned, “The NAV is theoretical at best. All of you involved in fair value and NAVs, be you a fund accountant, treasurer or vendor—you all go through great pains each day to come up with an accurate NAV. You go through all these machinations down to one-one hundredth of a cent. But at the end of the day, it is all theoretical because five minutes later, all of those prices and exchange rates have changed. At best, it is just a momentary snapshot.”
Thus, determining an accurate price should not be the end goal, O’Flaherty said. Rather, boards of directors should ensure that the funds they oversee have the right pricing and valuation processes in place, and that they are continually updated.
“If you do that, then you have the basis to lead to fair valuation and security assessment,” he said.
Risk management has become another key issue of fund boards, Moody said. Naturally, risk management includes oversight of investments and compliance with legal and regulatory parameters, he said. But it also should extend to operations and distribution, particularly in light of the more esoteric products investment advisors are creating, he said.
“If the manager opens up an alternative product with derivatives, the folks in operations and accounting might not have the experience or the technological tools to deal with them, so they might have to do manual work on Excel spreadsheets,” Moody noted. While the board is not responsible for the products, it is responsible for risk management processes, he said.
Problems might also arise from the fact that less than half of advisors have dedicated chief risk officers, Moody continued. Sixty-two percent of funds rely on their chief compliance offer to act as their chief risk officer, according to one industry survey, he noted. “If the advisor enters into a new, complicated product, the boards have to question whether the CCO can effectively manage that product.”
These central issues—complex products, accurate pricing and security assessment—have made audit committees more important than ever, speakers said.