alternativein1

About alternativein1

http://alternativein1.wpengine.com

Posts by Jacob Mohs:

Why Traditional Asset Managers Need Alternative Investments

The core thesis behind the creation of this site is that alternative investments are no longer alternative- they are an essential part of any portfolio. The Financial Times recently published an article highlighting a key trend that supports this thesis:

Fund houses buy up ‘alts specialists’

The $100 billion Club

According to the FT, more than a dozen fund groups known for mutual funds and ETFs reported at least a $100billion in alternative assets at the end of 2021. These include firms such as BlackRock, Franklin Templeton Pimco, and Invesco.

This chart shows the amount of alt assets at a few major firms.

The original article has an interactive version of this chart.

There are basically two ways mutual fund and ETF focused asset managers can expand into alternatives- build it or buy it. However, the latter method- asset manager M&A, is what seems to be making the biggest splash in the industry. For example, AllianceBernstein announced plans to purchase CarVal Investors, building its alternatives business to nearly $50 billion. Franklin Templeton is buying Lexington Partners, increasing its alternative asset AUM to $200 billion.

Why traditional asset managers need alternative investments

Why are traditional asset managers so keen to buy alternative asset managers? The key reason is investor demand. Institutional investors have all been increasing their allocation to private lending, private equity real estate, infrastructure, and private equity in recent years. A recent survey found that 86% of institutional limited partners intended to invest the same or more money in private capital in coming years.

So the institutional channel is big and growing. But the real story is the “mass affluent” retail investor demand for alternative funds:

The fund mangers also hope to capitalise on an expected wave of interest from wealthy retail clients looking for stable long-term returns at a time when bonds and equities have been volatile. Some envy the success of alternative managers in introducing products for the very rich, such as real estate and credit funds launched by BlackStone, the worlds largest private equity group.

Industry Impact

Most people don’t think of firms like BlackRock, Franklin Templeton, Pimco, or Invesco as alternative asset managers, yet they are starting to shift their focus. BlackRock CEO Larry Fink ‘s annual letter to shareholders mentioned that plans to accelerate growth in private markets were central to the group’s strategy. The entrance of large traditional fund managers into the retail alternative channel is going to dramatically alter the shape of the industry. They will open up new sales channels for alternative products, while also raising the bar in terms of quality and transparency.

In fact, traditional asset managers have already started to make a major impact on key niches of the alternative fund management industry, such as non-traded REITs and interval funds. The Blackrock Credit Strategies Fund is a closed end interval fund that launched in 2018. It now has $428.2 million in assets. When Franklin Templeton bought out Benefit Street Partners, they took over management of a non-traded REIT, now known as the Franklin BSP Real Estate Trust . The Invesco Senior Loan Fund is one of the longest running interval funds. Research at Interval Fund Tracker highlighted how well it weathered the global financial crisis of 2008-2009. The Invesco Dynamic Opportunities fund was previously a traditional exchange traded closed end fund, but it converted to an interval fund while staying on the exchange.

Private Markets Go Mainstream

The latest issue The Economist features a special report on Private Markets. This report provides broad historical context to the current boom in private equity, real estate, and other alternative assets. It analyzes the tailwinds that have driven record amounts of capital into private markets, and the risks and opportunities the industry is facing in the near future. Its a must read for anyone interested in alternative investments. As we’ve noted several times before- alternative investments have gone mainstream.

The article discusses how the pioneers of leveraged buyouts transformed and reinvented themselves into diversified alternative investment platforms with exposure to a wide range of assets. One section in particular focuses on how asset managers that traditionally focused on high end institutional clients are now focusing on marketing to mom and pop investors.

Quoting from the article:

The PE giants are hustling for high-end retail business from clients who count as “accredited” investors whom regulators deem sophisticated enough to buy private assets. The big firms are also strengthening private-wealth teams, in some cases poaching from banks. Alisa Wood of KKR says the firm is looking to raise a third or more of its capital from retail investors. Apollo expects individuals and advisers to invest $50bn over the next five years. To that end, in December Apollo acquired part of Griffin Capital, a Los Angeles -based fund manger. The next target is the “mas affluent”, or merely quite well off, who have little invested in private markets and want more. Several firms, including Blackstone and Brookfield, have launched or are working on PE, credit, property or infrastructure funds tailored to smaller investors.

Product Innovation to Meet Retail Needs

These new investment products cover a wide range of asset classes, and can come in a wide range of product wrappers. Interval Funds and Tender Offer Funds have become more common in recent years. Non-traded REITs and Non-traded BDCs are also important structures, especially for real estate and credit exposure. Regardless of the wrapper, asset managers need to innovate to create solutions that meet retail investor needs. Two important challenges are the need for liquidity, and the need for transparency.

One difficulty over turning this retail trickle into a flood is illiquidity. REtail investors want to trade in and out of investments at a reliable net asset value, if not daily then weekly or monthly. That is not easy to engineer with private assets. Some a the cutting edge are making headway. Swiss-headquartered PArtners Group manages over $36bn in open-ended PE funds for investors including wealthy retail clients. Investors receive monthly net asset values and can redeem ata 30-90 day notices(although funds can halt redemptions during market turmoil).

For more information about Partners Group and their massively successful closed end fund products, check out this article on TenderOfferFunds.com

Business Strategy

Meeting retail investor needs is an essential part of the long run business strategy for all major alternative asset management firms. As the article notes:

The retail pus aims both to increase clients and to grow fee based revenues. This goes hand in hand with the objective of raising more “perpetual” capital. Not only are profits from traditional PE funds erratic, but also the funds have to be wound up, typically after ten years. Big firms want to move away from this here-today-sold tomorrow model. They like vehicles that can invest for longer, or are open-ended. , avoiding the need to go cap in hand to investors every few years.

A lot of alternative asset managers are publicly traded, and also need to consider how the public markets view fee streams. In general, asset managers with a higher percentage of base management fees from permanent capital vehicles will command a higher valuation.

Oaktree Launches Non-traded BDC : Oaktree Strategic Credit Fund

Oaktree Capital filed a registration statement for a new non-traded BDC: Oaktree Strategic Credit Fund. Oaktree is joining Bain Capital, Apollo, and Blackstone by making high net worth retail investors an important part of their fundraising strategy. In this article we provide a preview of Oaktree’s new non-traded BDC.

Oaktree Strategic Credit Investment Strategy

According to the prospectus, Oaktree Strategic Credit will focus on private debt opportunities, mainly in US companies. The prospectus also allows them to invest in European companies. However, to maintain compliance with the regulatory requirements of a business development company, they must put at leas ty70% of their assets in private US companies. Most of their debt investments will be non rated. They will invest opportunistically, so the investment portfolio will change with market conditions. Oaktree believes the market for lending to private companies is underserved. Key themes they will focus on will be stressed sector/rescue lending, situational lending, sponsor related financing, secondary private loans, and loan portfolios.

Fund Structure

Oaktree Strategic Credit Fund has a maximum capital raise of $5 billion The latest prospectus includes three classes of shares: Class S, Class D, and Class I . Class S shares will have a servicing/distribution fee of 0.85% per year, with a 3.5% cap. Class D wil have a shareholder servicing/distribution fee of 0.25% per year with a 1.5% cap. Class I shares will not have any shareholder servicing or distribution fees. The minimum initial investment for Class I shares is $1 million.

Oaktree’s new BDC will have a base management fee of 1.25% per year. Additionally, it will charge an incentive fee consisting of two parts. The first part of the incentive fee is based on income- the manager will receive 12.5% of pre incentive fee net investment income over a 5.0% hurdle rate. Additionally, the fund will pay the manager 12.5% of cumulative realized capital gains.

Notably this fee structure is nearly identical to that of Apollo’s new non-traded BDC.

About Oaktree Capital

Oaktree Capital Management is a global alternative asset manager with more than $158 billion in AUM as of 9/30/2021, according to its website. They have deep expertise across the capital structure. They organize their investment professionals into four broad categories: credit, private equity, real assets, and listed equities. Well known for their expertise in distressed debt, approximately 69% of their assets are in credit. Their clients include 67 of the 100 largest pension plans in the US, 40 state retirement plans along with 15 major sovereign wealth funds and 500+ corporations around the world. In 2019 Brookfield Asset Management acquired a majority interest in Oaktree. Oaktree entered the non-traded REIT space back in 2017. After transitioning the management over to Brookfield, this REIT has over $500 million in net assets. It is likely Oaktree will quickly gain market share in the non-traded BDC industry.

Looking for data on non-traded BDCS? Click here to access our free tools and data.

Fund Launch: Apollo Debt Solutions BDC

Apollo Global Management has launched a new non-traded BDC: Apollo Debt Solutions BDC. The SEC declared the Apollo’s new BDC effective on October 29, 2021.

Investment Strategy

According to the prospectus for Apollo Global Debt Solutions:

Our investment strategy is focused on sourcing deals directly with large private U.S. borrowers who seek access to financing and who historically relied heavily on bank lending or capital markets. We believe there is a market opportunity for these large private U.S. borrowers.

They will focus on companies with at least $75 million in EBITDA, but they might adjust this threshold for market disruptions, M&A related charges and synergies, etc. Quoting from the prospectus again:

We believe this opportunity set generates favorable pricing and more rigorous structural protections relative to that offered by investments in the broadly syndicated markets. From time to time, we may also invest in loans and debt securities issued by corporate borrowers outside of the private large borrower space to the extent we believe such investments enhance the overall risk/return profile for our shareholders and help us meet our investment objectives.

The fund was launched as a blind pool, but they already had a financing facility agreement on the date of the launch.

Apollo Debt Solutions Fund Structure

Apollo Debt Solutions BDC has a maximum capital raise of $5 million. The latest prospectus includes three classes of shares: Class S, Class D, and Class I . Class S shares will have a servicing/distribution fee of 0.85% per year, with a 3.5% cap. Class D wil have a shareholder servicing/distribution fee of 0.25% per year with a 1.5% cap. Class I shares will not have any shareholder servicing or distribution fees.

Apollo’s new BDC will have a base management fee of 1.25% per year. Additionally, it will charge an incentive fee consisting of two parts. The first part of the incentive fee is based on income- the manager will receive 12.5% of pre incentive fee net investment income over a 5.0% hurdle rate. Additionally, the fund will pay the manger 12.5% of cumulative realized capital gains.

About Apollo Global Management

Apollo is a leading global alternative asset manager with approximately $480 billion in AUM, according to a recent investor presentation. Apollo Global Management is listed on the NYSE under the symbol APO. They have three main business segments: Private Equity, Credit, and Real Assets. IT believes it is distinct from other alternative managers in the way it operates its three primary business segments: private equity, credit, and real assets, in an integrated manner. Apollo has been part of a broader trend of institutional alternative managers making the big shift into the retail channel. On recent conference calls, management has hinted at early success raising capital from retail investors.

Apollo Debt Solutions will be a good fund to watch in the coming months. Blackstone’s non-traded BDC has over $18 billion in assets. It will be interesting to see if Apollo achieves similar fundraising success.

Want to learn more about non-traded BDCS? Click here to access free tools and data.

Hospitality Investors Trust Files For Bankruptcy

Things went from bad to worse at Hospitality Investors Trust. Last year, they had to enter into a forbearance agreement with certain lenders. Earlier this year the DI Wire reported on a liquidity dilemma at Hospitality Investors Trust. Now at last the inevitable has happened. Hospitality Investors Trust has filed for bankruptcy.

FactRight sums up the current situation here:

On May 19, 2021, Hospitality Investors Trust, Inc. (HIT) announced that it and certain operating subsidiaries had filed voluntary bankruptcy petitions under Chapter 11 of the Bankruptcy Code. The United States Bankruptcy Court for the District of Delaware is administering the cases under the caption In re: Hospitality Investors Trust, Inc., et al.
HIT and affiliates filed for first day relief including the authority to pay certain vendors, suppliers and employee wages and benefits in the ordinary course of business as well as for approval of a debtor in possession (DIP) financing facility of up to $65 million in aggregate principal balance. Brookfield (via multiple affiliates), which had previously made an approximately $300 million investment in HIT, has agreed under a restructuring support agreement to “support and take any and all commercially reasonable, necessary or appropriate actions in furtherance of the consummation of the restructuring transactions.” HIT noted that it had received approval from “certain of the Company’s lenders, franchisors and other parties in interests” regarding the planned restructuring and that implementation of the planned restructuring will not constitute a default or triggering event under certain loans or financial obligations.

Under the proposed restructuring plan, the existing common stock will be cancelled and exchanged into non-transferable contingent valuation rights (CVRs) which will receive distributions once certain hurdles are achieved for Brookfield. The maximum value of the CVRs is $6.00. Considering the retail investors originally bought in at $25.00, this is probably a painful outcome. At least there will be some tax benefits.

Backstory

Hospitality Investors Trust has a long and sordid backstory. Formerly known as American Realty Capital Hospitality Trust, it raised capital quickly from the broker-dealer channel right at the peak of Nick Schorsch’s reign as the non-traded REIT Czar. However it got overextended financially, and everything unwound right as an accounting scandal broke out at American Realty(now known as VEREIT. (See “History Repeats: The Serpent on the Rock” for details on this). Eventually they struck a Faustian bargain with Brookfield, who bailed them out in exchange for some extremely generous preferred stock. Then the pandemic hit.

Possible Recovery?

Many analysts have speculated that there is a lot of pent up demand for travel. If that is the case, then there is a lot of upside for the hospitality industry. There might be upside for Hospitality Investors Trust, but its complex capital structure means it will take a lot before the outside shareholders benefit. Its possible that the CVRs resulting from this bankruptcy might achieve the full targeted payout of $6.00. Considering that shares have recently exchanged hands at $0.50, this might be an extreme deep value play, albeit with a lot of risk. One thing is for certain: Brookfield will do extremely well no matter what happens.

Fund Launch: KKR Real Estate Select Trust

KKR has launched a new non-traded REIT: KKR Real Estate Select Trust, Inc. The REIT filed an initial registration statement on May 28, 2020, and the SEC declared the revised version effective on May 18, 2021. In this article we examine the key features of KKR’s new non-traded REIT.

KKR Real Estate Select Trust Investment Strategy

KKR Real Estate Select Trust’s vestment objective is to provide attractive current income and its secondary objective is to provide long term capital appreciation. The REIT has a broad investment thesis targeting single-tenant net lease properties, preferred equity investments and private real estate debt in the United States, as well as developed markets in Asia and Europe. The prospectus highlights several trends that it believes will be favorable to the REIT’s investment strategy. In particular, it plans to focus on opportunities in population centers that have favorable demographic, technological and preference changes accelerating urbanization.

Fund Structure

According to the prospectus, KKR Real Estate Select Trust is raising $2 billion, and offering four different share classes. The perpetual life REIT will price NAV and accept subscriptions daily. Class S shares will have an up front sales load of 3.0%, and a dealer manager fee of 0.5%. Class D, Class U, and Class I shares have no up front selling costs. However Class S and Class U both pay ongoing distribution fees of 0.60%, and shareholder servicing fees of 0.25%, while Class D shares pay shareholder servicing fees of 0.25% Class I shares have no distribution or servicing fees. The REIT will charge a base management fee of 1.25%, and a performance incentive fee of 12.5% of portfolio operating income.

More details on KKR Real Estate Select Trust’s fee structure and investment strategy is available to premium subscribers. Click here to learn more about data and tools available to premium subscribers.

KKR Select Real Estate Select Trust is relatively unique in that it is both a non-traded REIT, and a Tender Offer Fund. Real Estate Investment Trust, or “REIT” refers to its tax status. As a REIT, it is subject to a range of requirements, especially around distributing income to investors. As a tender offer fund, it is subject to disclosure requirements of the 1940 act. Broadstone Real Estate Access Fund, a closed end interval fund, is another example of a fund using this combination of regulatory structures.

About KKR

Founded in 1976 KKR was one of the pioneers in private equity and alternative investments. Today it operates globally, with 20 offices, and 1600 employees. As of December 31, 2020, KKR had approximately $252 billion in assets under management. Since 2004, KKR’s AUM has grown twice as fast as the broader alternative investment industry. Private equity remains the dominant strategy in KKR’s portfolio, accounting for 68% of total AUM. In recent years they have been expanding their real estate capabilities. KKR Real Estate has around 90 employees dedicated to real estate, with AUM of approximately $28 billion Additionally KKR has been expanding its focus on retail investors, with the launch of various non-traded BDC and Interval Fund products. This is KKR’s first non-traded REIT.

Is David Swensen To Blame For High Fees?

The untimely passing of David Swensen has led to a lot of self reflection in the world of asset allocators and alternative investment professionals. Swensen pioneered an investing method that moved beyond traditional stocks and bonds, and into more exotic alternative investments and real assets. In a previous article, we highlighted the three pillars of David Swensen’s method of investing, as summarized in the Economist. John Authers of Bloomberg recently added to the voluminous commentary around his death.

Although the endowment method has been covered extensively in books, articles, and webinars, few imitators have been as successful at achieving the level of returns achieved by Swensen. As Authers notes:

But it’s still necessary to understand a little more about the man’s legacy. None of his imitators have managed to perform as well, even though many are just as clever as he was, and enjoyed comparably big inbuilt advantages. Why did Swensen apply his own model so much better than the many brilliant asset allocators who have followed him?

Authers posits that he enjoyed first mover advantage. When he started allocating to hedge funds and private equity funds, they were exploiting truly unique market anomalies that no one else had noticed. Over time more and more funds entered the space, and the returns were arbitraged away. Moreover, more and more opportunistic and unscrupulous people entered the industry. Meanwhile, the early successful funds closed to new investors. Late adopters were left with a difficult problem of filtering a less stellar opportunity set.

Yet there was more Swensen’s success than just the first mover advantage. Quoting from the article:

This is important to note because there is some revisionism afoot. He showed that it was possible to make a lot of money in alternative assets; many alternative asset managers showed that it was possible to get very rich by feeding the appetite for their product that Yale had created. Hence there are attempts to blame Swensen for the growth of “2-and-20” hedge funds, after a decade in which their business model has looked ever worse.
That is more than a little unfair. What follows is my attempt to summarize and synthesize what might be called the “soft skills” that allowed Swensen to make the Yale model work so well for so long.

Everybody has their own interpretation of what made Swensen succesful. Here are the key tenets that Authers identified:

Know your comparative advantage
Be the best client you can be
Be a Coach
Be a scout
Don’t just take what’s on offer
Minimize turnover
Treat your bosses well(and choose your bosses if you can)
Groom successors
Risk control, risk control, risk control

Perhaps the last item is the most underrated. Indeed all of the other tenets of Swensen’s method were joined under the discipline of risk control. He had deeply studied academic literature on risk management, and this allowed him to be comfortable making contrarian long term bets.

Its well worth checking out the full article on Bloomberg. Checkout our previous commentary on the endowment method here.

3 Pillars of David Swensen’s Method

David Swensen (January 26, 1954- May 5, 2021) served as chief investment officer at the Yale University Endowment from 1985 until his death in 2021. His legacy is that of a pioneer in the world of asset allocation and alternative investments. Prior to the 1980s, endowments had invested exclusively in stocks and bonds, with an especially large allocation to the latter. His performance far exceeded that of other university endowments. When he started the endowment had $1 billion in assets. When he died it had $31 billion. Yet a 31x return actually understates his impact.

He attracted a legion of imitators, forever altering the intellectual landscape of investing. . His approach, which included a large allocation to equities and alternative investment products, but a relatively low allocation to fixed income is sometimes called the “endowment method”. Others just call it the Swensen Approach. Many family offices, sovereign wealth funds, and large pension funds use the Swensen Approach.

A whole slew of obituaries and commentaries followed his untimely death at the relatively young age of 67. These obituaries were a chance to reflect both on a life well lived, and an intellectual legacy. The Economist recently featured an article that outlined the three pillars of David Swensen’s thinking. These three pillars also formed the basis of his competitive advantage.

Time Horizon

While most investors are focused on day to day price movements, endowments think long term. Like really long term. The defining feature of endowments is that they have obligations extending far out into the future. Unlike most investors, they don’t need to worry much about liquidity and ease of trading. Endowments can harvest an illiquidity premium. Being more patient than your counterparties can be an important advantage in markets.

Information

Public stock markets are mostly efficient. It’s nearly impossible to get an informational edge. In contrast, private markets reward people who do deeper homework. Reliable data and analysis are harder to acquire in public markets. Swensen built out research teams to cover markets where nobody else was paying attention.

Closely related to this, Swensen was able to get in on the ground floor with a lot of emerging managers in the early days of alternative investments. Many of the funds he invested in during the 1980s and 1990s have stellar track records, and are now closed to new investors. Superior access is a corollary to superior information. While anyone can theoretically get access to superior information on individuals in private markets, superior access requires being in the right place at the right time, and developing connections over years. There is a feedback loop that allows superior access to grow in importance.

Contrarian Mindset

Swensen was a contrarian before it was cool. The extent of Swensen’s contrarian mindset is best illustrated with an anecdote:

Following the stockmarket crash in October 1987, he had loaded up on company shares, which had become much cheaper, by selling bonds, which had risen in price. This rebalancing was in line with the fund’s agreed policy. But set against the prevailing market gloom, it looked rash. His investment committee was worried. One member warned that there would be “hell to pay” if Yale got it wrong. But Mr Swensen stuck to his guns. The decision stood—and paid off handsomely.

Another notable aspect of Swensen’s legacy is his mentorship. Dozens of alumni of Yale’s Endowment fund have taken senior positions at other endowments.

Invesco Launches Non-Traded REIT

Invesco has entered the non-traded REIT space with the launch of a new fund: the Invesco Real Estate Income Trust, Inc. This fund filed an initial draft registration statement on December 31, 2019, and conducted a private offering in 2020. On March 31, 2021, it filed a registration statement for a public offering, which the SEC declared effective on May 14, 2021.

Investment Strategy

The Fund’s investment objective is current income and capital appreciation. It will invest primarily in stabilized, income-oriented commercial real estate in the United States. Invesco Real EState Income Trust will invest in a broad range of property types including multifamily, industrial, retail, office, healthcare, student housing, hotels, senior living, data centers and self-storage. It will use the FTSE EPRA/Nareit Developed Index as its benchmark.

The fund has a mandate that allows it to invest globally. In order to fund liquidity for distribution payments, and the repurchase plan, it may also hold more liquid real estate related securities.

Since the fund conducted a private offering, it already has $31 million in net assets in the portfolio. The following table summarizes its property type allocation.

Share Classes

According to its prospectus, Invesco Real Estate Income Trust is raising up to $3 billion, and will have a total of 5 share classes. Class T, Class S, and Class D shares all have varying levels of up front selling commissions. Class I and Class E shares however, will not have any upfront selling costs. The minimum initial investment for Class T, Class S, Class D and Class E shares is $2,500. Class I shares are intended for institutional investors, and have a $1,000,000 minimum initial investment.

The fund will pay an annual management fee equal to 1.0% of NAV. Additionally, the Adviser will be entitled to a performance allocation of 12.5% over a 6.0% hurdle, with a high water mark, and catch up feature. The fund will not charge any acquisition, disposition, or financing coordination fees.

More details on Invesco Real Estate Income Trust’s strategy is available to premium subscribers. Click here to learn more about data and tools available to premium subscribers.

About Invesco

Invesco is a global investment manager with $1.2 trillion in assets under management. Headquartered in Atlanta, Georgia, it has more than 8000 employees branch offices in 20 countries. Invesco’s common stock also trades on the New York Stock Exchange under the ticker symbol “IVZ”. Invesco’s funds have a diverse investor base. According to its most recent annual report, approximately 70% of IVZ’s AUM is from retail investors, and 30% is from institutional investors. Invesco Real Estate buys and sells approximately $7.4 billion in real estate globally, in addition to real estate related securities.

Although This is Invesco’s first non-traded REIT, it has extensive experience marketing alternative investment products in the retail channel. Notably, Invesco has one of the longest running interval funds. Additionally, it is in the process of converting one of its closed end funds into an interval fund.

Why Firms Should Adopt the CFA Asset Manager Code

The CFA Institute Asset Manager Code is a valuable guide for asset management firms that aspire to high standards. The purpose of the Asset Manager Code is to foster a culture of ethical and professional behavior that protects the interest of investors, protects and enhances the reputation of the investment firms. It also provides a useful framework for asset management firms to provide services in a fair and professional manner with full disclosure. The Code helps asset managers gain the confidence of clients, ultimately leading to higher profits.

Broadly speaking, there are six general principles to the Code:

Managers must

Act in a professional and ethical manner at all times
Act for the benefit of clients
Act with independence and objectivity
Act with skill, competence, and diligence
Communicate with clients in a timely and accurate manner.
Uphold the applicable rules governing capital markets.

The details matter. In this article we’ll examine the key sections of the Asset Manager code.

There are six sections to the Code:

Loyalty to Clients
Investment Process and Actions
Trading
Risk Management, Compliance and Support
Performance and Valuation
Disclosures

Loyalty to Clients

A firm must prioritize clients interests ahead of firm and employees, maintain confidentiality, and refuse inappropriate gifts or business relationships.

Firms need to develop policies and procedures to ensure that client interests are paramount in all aspects of the manager-client relationship. This includes things like investment selection, transactions, monitoring and custody. Managers should avoid situations that create conflict of interest. Moreover they should implement compensation arrangements that ensure these interests are aligned, and no in conflict.

This also includes being careful to maintain client confidentiality (ie a privacy policy). This of course does not apply if information must be legally disclosed.

Asset managers also need to be careful to avoid getting into business relationships that create conflicts of interest. This can be challenging for due diligence analysts who constantly receive gifts from potential investments.

Investment Process and Actions

This requires reasonable care and judgment when making investment decisions, fair dealing, sufficient due diligence, and avoiding manipulation of securities prices and volume.

A rigorous due diligence process is part of the Asset Manager code. This means using reasonable care and prudent judgement in setting the investment policy, and having a reasonable and adequate basis for all investment decisions.

Manipulating securities market, or treating clients unfairly is a violation of this part of the code. Note that this provision doesn’t prohibit side-letter arrangements, als long as they are fairly allocated among similarly situate clients for whom the opportunity is suitable.

The CFA Institute provides additional guidance on this part of the code that pertains to the differences between managing pooled funds and separate accounts. When a pooled vehicle has a specific mandate, strategy, or style, the investors should take only investment actions that are consistent with those constraints or objectives. If there is any change in the investment style or strategy, you should inform investors before making the changes. That way clients can decide if the new strategy still fits with their objectives.

When managing separate accounts there are additional subtleties. You should evaluate and understand the client’s objectives, risk tolerance, time horizon, liquidity needs, financial constraints and unique tax, legal, and regulatory constraints that would impact the policy. Only make decisions that are suitable for clients given these circumstances.

Trading

This section includes not using material non-public info for trading purposes (regardless of local law), the prioritization of clients over the firm, the proper use of client commissions, and making sure your clients get best execution and the development policies of fair and equitable trade allocation.

Firms need to establish compliance procedures to ensure they avoid insider trading.
Additionally, they need to give priority to clients made on behalf of the client over those that benefit the Manager’s own interests.

Commissions generated from trades should only be used t o pay for investment related products or services that assist in the investment management process, not with management of the firm. This goes back to the general principle of putting clients first. Closely related, Managers need to seek best trade execution for clients. This can add a lot of value for strategies that deal in illiquid securities, or make large investments. As with everything else, the firm needs to document this with proper policies and procedures.

Risk Management, Compliance and Support

The asset manager code requires detailed policies and procedures in order to ensure compliance with the Asset Manager Code. The firm’s compliance department needs to develop extensive written policies and procedures to ensure that all activities comply with the Asset Manager Code, and with all legal and regulatory requirements.

The compliance officer should be independent from investment operations if possible. Additionally, they should report directly to the CEO or board. The compliance officer also needs to make sure all client communications are accurate and complete. Additionally, third party confirmation is essential. Maintain records for at least seven years, or as required by local law. Keeping top quality staff isn’t just good business sense, its also required by the Asset Manager Code. A disaster recovery and business continuity plan is also part of this section of the Asset Manager Code.

The firm should establish a firmwide risk management process that identifies, measures and managers the risk position of the manager. An effective risk management process will identify risk factors for individual portfolios, as well as for the manager itself. This includes, stress tests, scenario testa, and backtests.

Performance and Valuation

The asset manager code requires the use of fair market prices or commonly used valuation methods, as well as data that is accurate, relevant, timely and complete.

Managers need to present performance data that is fair, accurate, relevant , timely and complete. Its critical that managers must not misrepresent hte performance of individual portfolios or their firm. The GIPS standard provide a good standard, although its not required. MAnagers should not cherry pick performance, or take credit for performance that occurred before they took over management.

Some securities can be hard to value. The code requires Managers to use fair market prices to value client holdings and apply, in good faith, methods to determine the fair value of any securities for which no independent third party market quotation is available. Management fees are generally calculated based on asset valuation, so this has the potential to crate a major conflict of interests. The best practices is to transfer responsibility to an independent third party. For pooled funds with independent directors, best practices is to have independent directors review valuation.

Disclosures

Disclosure is a theme that runs through all sections of the Asset Manager Code . Firms must provide ongoing , timely communications with clients. These communications must be truthful, accurate, complete, and understandable. Moreover these communications must include all material facts regarding the firm, personnel, investments, and the investment process.

Key guidance for disclosure:

Communicate with clients on an ongoing and timely basis. Managers should establish lines of communication that fit with their situation.
Ensure that disclousrs are truthful, accurate, complete and understandable and a re presented in a format that communicates effectively.
Include any material facts when making disclourures or providing information to clients regarding htemselves, their personnel, investments, or the investment process.
Things that require disclosing include
- Conflicts of interest from relationships with brokers or other entities, other client accounts, fee structures or other matters
- Regulatory or disciplinary actions against the manager.
- Thei investment proces , including information regarding lock up periods, strategies, risk factors, and use of derivatives and leverage
- Management fees and other investment costs charged to investors, including what costs are included and methodologies for determining fees and costs.
- The amount of any soft or bundled commissions, the goods and or services received, and how they benefit client
- Performance of clients investments on regular basis. The CFA Institute recommends at least quarterly when possible, and within 30 days after th end of the quarter
- Valuation methods used – must be specific, not boilerplate
- Shareholder voting policies
- Trade allocation policies
- Results of the fund audits.
- Significant personnel changes
- Risk management processes.

By adopting this code, firms demonstrate their commitment to ethical behavior and the protection of investor interests.

1 2 3 4