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.