Time to Market

"Time to market" describes delays in investing applications or selling assets to fund redemptions. Probably the easiest way to illustrate this concept is by way of an example where a fund invests into an external fund; this situation would be familiar to anyone operating a platform. In this example, say due to manual processes, it takes 4 days for the funds to be invested in the underlying fund:

 

Day 0, NAV 1,000, Units on Issue 1,000, Unit Price 1.00

Day 5, NAV 1,060, Units on Issue 1,000, Unit Price 1.06

Underlying Fund
Day 0, NAV 1,000, Units on Issue 1,000, Unit Price 1.00

Day 5, NAV 1,060, Units on Issue 1,000, Unit Price 1.06

 

In this example we have a fund with issued units of 1,000 and a unit price that has steadily increased from inception at $1.00 to Day 5 at $1.06. The fund holds all the assets of the underlying fund; and the price has moved similarly.

 

Now continuing with the example say on Day 5 an investor lodged an application for $1,000. In this example it would take 4 days, Day 9, before those funds would be unitised in the underlying fund. The funds are unitised in the fund at $1.06 giving 943 units. The asset, the units in the underlying fund, are valued at the last available price, being $1.06. It is not until Day 10 that the funds are unitised and the investment confirmation is received detailing the actual unit received. At that time the valuation must be adjusted.

 

Day 5, NAV 1,060, Units on issue 1,000, Unit price 1.06

Day 6, NAV 2,060, Units on issue 1,943, Unit price, 1.06
Day 10, NAV 2,100, Units on issue 1,943, Unit price 1.08

Underlying Fund
Day 5, NAV 1,060, Units on issue 1,000, Unit price 1.06

Day 6, NAV 1,060, Units on issue 1,000, Unit price, 1.06
Day 10, NAV 2,100, Units on issue 1,909, Unit price 1.10

 

As a result of the mis-match the existing unitholders have suffered a loss; and are therefore have not been treated equally.

 

To correct the situation the operator would need to compensate the fund to the tune of $37.74 - 1,943 units * (1.10 – 1.08).

Time to market issues exist because we operate in the real world. There are many fund structures that have 7 or more interfunding layers. These layers can be external (as in the case of Platforms) or internal or a combination of both. Depending on the systems being used each layer can take a day for the funds to flow through one layer of the structure. So 7 levels is 7 days for the funds to be actually invested.

Although 99% of the market is using forward pricing this does come with its issues. Just looking at a standard flow of funds:

 

• Daily cut-off for applications/redemptions: 3pm
• Processing completed: by 7pm
• Unit price calculated for prior day: 10am
• Cash availability to fund manager: 11am

However the units were issued based on the valuation for the prior day. The cash wasn’t invested until the next day, at best. Some fund managers have tried to avoid this by taking cash flow estimates at the end of the day and then taking futures or physical positions to cover any large flows overnight.

 

In most situations time to market will not be an issue as the funds flow will be a small proportion of the fund size however exceptions always exist (eg GFC).

 

The regulations provide little guidance on time to market issues. Section 10.8 of Standard 8 allows units to be issued prior to funds being received; but this really doesn’t help. You can use the standard 30 basis points and $20 compensation rules however most of us are now using much tighter tolerances.

 

There are now automated solutions for some of these issues where some unit registry systems allow cash to be flowed through the interfunding structure on the same day. However this solution only works for trusts within the same operator or using the same systems which still leave issues where one trust is investing in an external trust.

Unfortunately I don’t have any solution except to say:

• Be aware of the level of interfunding within your products and the associated time to market issues
• Of course the issue is impacted by size of cash flow in relation to fund size so look at having some safety checks within the process to monitor the cash flows.
• And then have a plan on what to do if the impact exceeds your thresholds.  

Is the focus on fund financial statements warranted?

All managed investment schemes are required to prepare annual financial statements in accordance with Australian Accounting Standards (AASBs) as outlined in the Corporations Act

 

Function of Financial Statements

 

To meet the SAC 2 objective of providing information useful for decision making and discharging accountability, financial reports should disclose information relevant to the assessment of performance, financial position, and financing and investing activities, including information about compliance (SAC 2, para.45). - Gallery, Gerry and Gallery, Natalie, 2003

 

But are investment fund financial statements really used for this purpose? In my over 20 years preparing fund financial statements I have had only one request for a copy of a financial statement. So why is so much time, effort and expense put into producing a report that is not useful?

 

There are a number of reasons for the lack of investor interest in a fund’s financial statements as compared to listed company financial statements.

 

Decision Making: As an investor in a managed investment scheme the financial statement provides little information that will influence the decision to invest or divest. Financial statements are required by the Corporations Act s319 to be completed and lodged by 30 September and in most case given the complexity of preparation and arranging board meeting for signing most funds will complete the reports within 1 to 2 weeks prior to 30 September. With an Australian sharemarket that has shown high volatility in line with the rest of the world in the past few years information that is reported 3 months after the event is virtually useless.

 

In deciding whether to invest in a fund an investor will review the funds PDS and financial advisors are required by law to provide a copy to all investors when providing advice. The PDS provides details of the parameters that the investments will be managed within along with historic performance. In the Financial Services Guide it states that if an Adviser makes a recommendation to about a particular financial product they must provide a copy of the PDS prepared by the product provider. This will contain information that will assist them in making an informed decision about that product. The PDS includes information about the costs and details of other fees and charges which may apply, including commission payments to financial advisers. The FSG does not require a copy of the funds financial statement o be provided to the investor

 

Accountability: The accountability of the fund trustee’s differs from that of a company’s board in that a managed fund is supervised under much stricter parameters that the management of a company. The PDS sets out how a fund will be managed (for example, an Australian Share fund may invest between 80% and 100% in Australian Equities with the remainder in cash). Therefore the fund’s trustees discharge their accountability obligations to the unitholders in ensuring the fund is managed within these parameters. All investment managers have pre and post trade compliance systems in place to ensure these rules are followed with strict internal penalties for breaches.

 

Performance: An investor will assess a fund’s investment performance from league tables (Morningstar, Investsmart, etc) not from a financial statement.

 

Compliance: Managed investment schemes must lodge an audit report of their compliance plan, under s601HG of the Corporations Act by 30 September each year which will clearly highlight any compliance breaches. Again the financial statement is not the vehicle for obtaining this information.

 

Cost

 

The average fund financial statement costs $5,000 per year to produce (based on an average of outsource provider rate cards). When coupled with the cost of the audit which has been estimated at $39,000 per year this is a total of $44,000 per year to produce a statement of no value. When extrapolated across all managed schemes in Australia this becomes a lot of effort for little return.

 

Process

 

The significant level of scrutiny by regulators and increased complexity of regulations has resulted in a challenging environment for those responsible for producing mutual fund shareholder reports within the 60 day regulatory reporting requirement. With an average processing cost of $5,000 per year combined with the cyclical nature of report production means that investment managers need to optimise processing efficiency and shrink the delivery times inherent within the reporting cycle.

 

Given the lack of investor reliance on financial statements their production becomes a regulatory reporting exercise similarly to producing a tax returns or a BAS return. And no investment manager would strive to be the best in producing these returns so why would they want to be the best at producing financial statements. This requires a change in approach from the Board down to ensure the right focus is placed on this activity. The focus should be on value adding activities that improve shareholder returns; preparing financial statements is a risk minimisation exercise to avoid regulatory penalties.

So for a non-value add process that is expensive and time critical it is important to consistently apply some or all of the following practices:

• Educate the Board and key stakeholders on the differences between fund financial statements and company financial statements
• Create the first draft early and is accurate and complete when distributed.
• Schedule pre-period reviews to get a head-start on resolving issues such as those that often accompany the purchase of new securities or changes to regulations.
• Complete and review static components of the report prior to period-end.
• Maintain a library of standard language.
• Have well defined reviewers’ roles and responsibilities for each level of review
• Utilise a financial reporting application that has built-in automated proofs.
• Utilise analytical tools for those reviews that cannot be built into the system.
• Develop and adhere to a materiality policy, particularly when considering making changes late in the reporting cycle.

Summary

 

The preparation of fund financial statements is an expensive and time critical task that when assessed against the users requirements it is a non-value add function. As a result the importance of this function should be de-emphasised and attention given to process improvement opportunities.