INDOS Financial attended Fund Forum in Copenhagen in June 2019. A number of prominent themes of the day were discussed during the four-day conference, including the seemingly unstoppable rise of exchange traded funds (ETFs) and passive products along with the emergence of disruptive technologies (i.e. distributed ledger, artificial intelligence, APIs [application programming interfaces], big data analytics, Robotic process automation, etc.).
Elsewhere, panellists spoke enthusiastically about the spectacular growth of ESG (environment, social, governance) investing and what it means for the funds’ industry. And finally, a handful of speakers shared their insights into some of the challenges facing the UCITS regime in the context of a recent high profile fund suspension. At the heart of both the ESG and UCITS’ liquidity debate lies fund governance. We take a look at these two key issues and articulate why it is so important to have robust governance underpinning them.
Why governance is so important to ESG
ESG was discussed extensively at Fund Forum, as asset managers increasingly attempt to incorporate it into their investment strategies. For many investment firms, ESG is a way for them to attract institutional investors; manage long-term risks in their portfolios and obtain better returns. But ESG is also a very complex issue. Client attitudes and approaches towards ESG do not always correlate. Furthermore, many of the ratings agencies or companies providing ESG analytics, have different methodologies, making it hard for all parties involved to properly assess whether or not they are fulfilling their ESG obligations.
Consequentially, there is a strong risk that some firms could deviate from their ESG mandates or even ‘greenwash’ their portfolios. To counteract this risk, the European Commission (EC) is attempting to come up with a taxonomy to introduce some much needed clarity on ESG standards. Some experts pointed out it is far easier to generate accurate scoring for an investment funds’ environmental record than it is, say, for their societal impact because the former is based on quantitative data whereas the latter is not. While ESG data standards are critical for assuaging investors, independent ESG oversight/monitoring will become an increasingly important component of fund governance. Such oversight will be critical to ensure that investment managers are compliant with their ESG mandates and do not greenwash their portfolios.
Recent high profile fund suspension emphasises need for stronger oversight
ESG is not the only area where governance is integral. For many retail and institutional investors, UCITS is a brand synonymous with safety and one that is underpinned by effective regulatory oversight. Managers of UCITS funds are obliged to invest in liquid assets, so that clients can redeem cash on a daily or weekly basis. As such, the regulation states that a UCITS cannot have more than 10% of its holdings in unlisted assets due to their lack of liquidity. If an asset cannot be sold easily or quickly, redemptions may sometimes have to be suspended in a worst case scenario, which calls into question the purported liquidity benefits of actually investing into a UCITS. Experts at Fund Forum referenced recent events, whereby a high-profile UK manager suspended its UCITS fund following withdrawals after a prolonged period of subpar performance.
The performance of the fund was not the primary issue for experts at Fund Forum. Instead, it is the fact that while the fund may have technically complied with the 10% UCITS threshold, the reality was rather different insofar as the illiquidity of its overall holdings was well in excess of 10%. The UK regulator is already assessing whether or not changes need to be made to the UCITS regulations in order to prevent similar situations arising again.
More broadly, several experts acknowledged this incident reinforced the importance of effective independent governance and oversight. Many fund directors and service providers working in the investment industry will be keeping a very watchful eye on developments following this particular episode. Hopefully, directors generally will be taking a more proactive stance when overseeing the activities of their funds as a result.