Home / Manager due diligence gets interesting as AIST model scrutinised

A lively session on the IMCA program last Friday in Sydney looked at the AIST proposal for managers to pay for the operational due diligence to be performed on them by ‘third-party’ assessors. Not everyone is happy with the proposal.

IMCA (the Investment Management Consultants Association), an educational body for investment professionals, organised the discussion led by Greg Nolan, a well-known super fund investment manager who is currently on the investment committee at LUCRF, and Grant Harslett, the general manager, investment and finance, at Maritime Super.

The AIST initiative, which would mean that managers pay for the operational due diligence performed on them by fund-sponsored third parties, such as the big accounting firms or specialist providers, was prompted by an APRA guidance note (Insights Note 1) issued in 2014.

That note says that super funds need to consider operational risk of their managers, in addition to investment risk. It stipulates that such an assessment should be undertaken by a ‘third party’.

Big funds with internal investment resources already undertake this work themselves. But they will often use providers such as Albourne Partners, Castle Hall, Mercer Sentinel or Morse Consulting to assist in the process. Smaller funds either use these specialists exclusively or rely on their asset consultants to take full responsibility for their manager recommendations.

APRA recognised that the system was inefficient and issued its ‘guidance note’ which has prompted the AIST initiative under discussion. Here are the pros and cons as discussed at the IMCA lunch last week.

Nolan said that all the big funds which he had spoken to and other interested parties agreed that the current system of operational due diligence (ODD) was inefficient and expensive, including duplication of work.

“AIST has tried to address all the issues highlighted by APRA,” he said. “This [the AIST proposal] is not a final document. It’s not a cover-all proposition. It’s not an attempt to duplicate what RSEs [funds] are currently doing. And it’s not a ‘tick-the-box exercise’…

This is a base level or starting point or a ‘core guide’ for funds which will reduce their costs associated with manager selection.”

Grant Harslett said that, at his fund (Maritime Super), the team had recognised that the work it was doing on manager due diligence was not up to the standard of its other work.

“We knew that the work being done by our asset consultants was not enough. But this work is not cheap for a fund which doesn’t have a lot of internal resources. To do this well is a lot of money, rivalling all the money we pay our asset consultants.”

Harslett said he believed that, over time, “we will get a better industry solution”.

The ‘perfect’ model is where the super fund appoints a provider to do the ODD and report directly back to the fund. “That’s the Rolls Royce model,” he said. “But we think that this, the Holden, is pretty good too. Better than what we have now.”

Nolan predicted that funds up to about $10 billion in size and which had just a handful of fulltime investment professionals on staff would make most use of the AIST ODD system. And. He said, larger funds would also use it for up to 80 per cent of their information requirements on ODD.

For instance, both Australian Super and Cbus – two of the country’s largest funds – were active supporters of the system, he said.

Questions from the floor at the IMCA session were interesting, mostly concerned with the efficacy of managers paying for ODD work done by prospective clients or their agents. As one family office fund manager said to the two super fund executives: “I’m paying for this service, not you, therefore I am the client. That’s a big conflict.”

It was also suggested there would be a temptation for the ODD ‘provider’ to ask for the manager to pay for additional advice on the services it performs, including, say, the 20 per cent of qualitative, information it seeks to give back to the client.

Harslett said that the group of AIST members behind the initiative was confident that big funds would drive quality control in the system among the providers. “Who’s paying for it shouldn’t be an issue,” he said.

There were two models being looked at: one which is audit-based and includes lots of ‘controls’ and the other which was more of the traditional advisory model. AIST was working with the various providers to combine them into one model, Harslett said.

Nolan also admitted that it was “an issue” that no other country with big pension schemes had attempted a manager-pays model. But, he said, there were some global managers with Australian subsidiaries which had already signed up. There were also others which had refused.

The issue of third-party administrators and responsible entities, such as Equity Trustees, was also raised. For retail funds, for instance, the RE will usually take responsibility for the fund and its distribution – for everything other than underlying investment strategies.

Harslett said that he was hopeful of talking to Mick O’Brien, the chief executive of Equity Trustees, and the others in that space, to tailor a solution to that issue.