Drawing lessons from the financial sector crisis: to chart a new path for the asset manager

Drawing lessons from the financial sector crisis: to chart a new path for the asset manager
Akwasi Adu BOAHENE

Asset Management plays a key role in any economy by acting as a conduit through which investors with surplus funds can channel them to those who need the funds to finance their business activities. Through this activity, the investor can meet investment objectives in terms of return and risk and the institution that received the funding can expand its business activities to meet the primary objective of maximising shareholder wealth.

It is therefore paramount that the allocation of capital through this process is done effectively (transferring funds to the sectors that are growing or have the potential to grow) and efficiently (the pricing or return is consistent with the risk taken) for both parties to meet their objectives.

The term Asset Management can be used interchangeably with Fund Management, since they are both generic terms used for managing funds professionally to achieve investment goals set out by an investor. Asset Managers are key players in the financial sector, which comprises three (3) categories, namely:

  • Banks and other deposit-taking institutions – which accept deposits to create loans
  • Insurance companies – which assist individuals and institutions to offset or manage risk
  • Asset Management firms – which provide effective and efficient means to pool funds to invest

As institutions which make investment decisions on behalf of clients, Asset Management firms propel growth of the real economy by helping corporates, banks and government agencies to meet their short- and long-term funding needs. They achieve this by providing ownership investments through equity capital in both primary (IPOs and private placements) and secondary markets; lending investment through credit capital via corporate bonds or money market instruments; and quasi-equity investment like a preferred stock or convertible preferred stock.

Some features of Asset Management firms which differentiate them from deposit- taking institutions like Banks (Delbecque et al. 2015) are:

  1. Agency Business Model – Although in charge of clients’ assets, these funds are not on their balance sheets. Fundamentally, the firms cannot guarantee returns but instead operate only on a best effort basis by allocating capital among various asset classes to generate returns.
  2. Limited Balance Sheet Risk – They do not act as lenders or providers of credit, and cannot use their balance sheet to leverage or fund their day-to-day operations. There is no asset-liability mismatch on the asset manager’s balance sheet.
  3. Protection of Client Assets – Clear segregation of client assets from those of the firm; to the extent that even if the firm goes bust, client funds should not be affected.
  4. Fee-Based Compensation – Fees are charged based on assets under management and can be reduced due to adverse market movement or withdrawals.

The financial crisis

The financial sector over the past four (4) years has been through some turmoil, which created uncertainty on the financial market. Over the period, the licences of seven (7) banks, twenty-three (23) Savings and Loans Institutions and three hundred and forty-seven (347) Microfinance Institutions were revoked by the Bank of Ghana (BoG). As a result of this clean-up exercise by the BoG, the banking industry is now positioned to play its role as an anchor of economic development.

There was a spillover effect of the financial crisis on Asset Management companies, which among other factors necessitated the revocation of licences from fifty-three (53) firms by the Securities and Exchange Commission (SEC).

There has been government intervention in releasing funds for payment to depositors and investors through receivers appointed by the regulators for the affected institutions. The receivers sold assets of the defunct companies to complement efforts of government in releasing funds for payment to depositors and investors.

One of the reasons for the revocation of licences was “Corporate governance weakness with weak Board oversight, poor accountability, and override of investment guidelines” (SEC circular, 2019).

Additionally, other reasons that resulted in the financial crisis were poor risk management culture, weak business models and related party transactions. This led to failure to meet client redemptions, inability to unwind positions in deposit-taking institutions, and poor portfolio performance owing to declining asset prices and impairments.

Lessons for investors/ asset owners

  1. Know yourself – What kind of investor are you?
  • Do you wish to have a regular stream of income? If that is the case, then your focus will be investing in fixed income instruments of high credit quality
  • Are you looking for capital appreciation and open to the possibility of losing some of your money? You can focus on both high-quality assets and take ownership positions in companies with strong earning potential and cash flow generating ability.
  • What is your willingness or capacity to accept risk? If you lose part or all the investment, will it severely affect your ability to meet your objectives?
  • Your investment horizon? How long do you intend to invest the money?

A licenced professional can assist you through profiling to advise on investment vehicles that are suitable for you.

  1. Diversify your investments

There is a need to spread investments across different asset classes and possibly sectors, to manage associated risk and also reduce the volatility of price movements of assets. Investors can also consider investing in pooled investments like mutual funds, unit trusts or exchange-traded funds which have a variety of asset classes in their portfolio.

  1. Consider investment from both return and risk perspectives

Every investment opportunity presents both return and risk, and therefore an investor should consider both in tandem when deciding to invest to avoid disappointments due to the negative impact of adverse market conditions.

  1. Request regular updates from your licenced investment advisor

Kindly ensure that you get regular updates on your investment from your licenced investment advisor, and make sure you understand its contents. Please ask for clarification if need be to address all your concerns.  Please discuss the performance of your investment with your licenced investment advisor. Investment performance analysis is a quality control process that seeks to answer the following questions:

  • How the investment is performing?
  • What was the reason for the performance?
  • How can the performance be improved?

By undertaking such periodic reviews, there will be no surprises when it is time to withdraw your funds.

Lessons for asset managers

  1. Good Risk Management System

Fund Managers need to ensure that the risk appetite of the investor is well-understood and incorporated into the investment decision-making. Per best practice, fund managers should not substitute their risk appetite for that of the client to cause a deviation from client expectations. Diversification is key in ensuring that the impact of an adverse market event on a portfolio is minimised.

There is a growing need to move beyond controlling and minimising risk and adopting a more proactive approach in better understanding the relationship between risk and return to enhance performance (Buy Side Risk Managers Forum and Capital Market Risk Advisors, 2008). In other words, risk should be considered from a broader perspective of the uncertainty of outcomes than just eliminating or minimising loss.

In adopting a strong risk management framework, there has to be clarity on how much risk the firm and its asset owners will accept (risk appetite). This should match the capacity to accept the risk (the amount of risk one can take to meet investment objectives) and also the approach to risk which should be informed by the assets to be invested in. Asset owners and managers should appreciate the behaviour of the assets through different business cycles. This should be well-articulated in the investment policy guidelines.

There should be a clear policy in place that incorporates a healthy balance between risk management and control. This is because whereas asset managers are paid to take the risk to earn competitive returns, risk controllers on the other side like internal audit or compliance officers are paid to monitor risk – which from their perspective is to reduce risk (Bacon 2002). The appropriate way to manage this conflict is by incorporating return and risk measures in the policy.

Asset Managers can also seek the services of third parties who are professionals to serve on their investment committees and constructively contribute to investment decisions, and also explore the possibility of professional indemnity cover to provide more comfort to investors.

  1. Due Diligence is not enough

It is not enough to only conduct due diligence and make investment decisions. There is a need for regular monitoring to ensure the issuers comply with the terms and conditions of any agreement. It is also important that there are regular engagements with principal officers to ascertain how well these firms are doing.

  1. Liquidity is Critical

A company must have the liquidity to address the obligations of investors when such requests are made. There is need to create a good balance between building wealth and making provisions to meet obligations. This is because failure to pay will result in a loss of confidence; and since trust is like capital, the absence of it may lead to a decline in business generation. Additionally, there is need to conduct scenario analyses to consider what can go wrong and how it can be mitigated.

  1. Operate a Sustainable Business Model

In addition to executing a business plan that provides a clear path for the achievement of objectives, it is imperative to operate a strong business model to ensure sustainability of the business.

Due to depressing margins, it is very challenging to operate an Asset Management business profitably on a sustainable basis. A very good business model will answer the following four questions as discussed in the St. Gallen Business Model (Gaussmann et al 2015).

Who: Defining who key customers or markets will be is important in operating the business successfully. There is a need to ensure that the customer base is well-diversified and not concentrated on only a few customers contributing over 80% of total revenue.  Customer or market definition is just one part of the issue, as building a broad customer base over a period to ensure healthy revenue growth is also very important.

What: The second dimension is what the customer wants. In other words, what is our value proposition?  Is it pricing, good customer service or operational excellence among others? The firm must decide how it intends to package its product and services to address the ever-changing needs of clients. The intended value to be delivered to investors and other stakeholders should be clearly defined.

How: Through which activities, processes, channels and supporting resources such as human capital and IT infrastructure will value be delivered? How efficient are our processes and systems to support the execution of our strategy?

Putting in place the right team with the right skillset and mindset who are performing the right activities, ably supported by the right IT systems, will deliver the right results.

Why: Actions should reflect the objectives of a profit-making organisation. The pricing of products and services should be higher than all associated costs. This calls for a granular approach in determining the cost of the product or service to assist in fee negotiation with clients.

  1. Put Ethics at the Heart of Decision-making

The actions of professionals should go beyond being compliant with regulations and adopting a deliberate attempt to incorporate ethics in decision-making. Ethics is what any society considers to be right or wrong. The society could be accountants, doctors or in this case investment professionals. For example, the CFA Institute has an asset manager’s code that could serve as a guide for investment professionals in Ghana.

It is very difficult to consider any decision or action to be just good or bad, since there may be instances when the consequences of these actions may initially impact some people negatively but will be for the common good of society in the long run. According to Colin Fisher and Co. cited in Sims (2014) in CIMA Financial Management, there are four kinds of ethical behaviour which can serve as a guide in addressing ethical problems should they arise:

Doing Bad: Causing harm through your actions or failing to prevent harm from being done. For example, withdrawing from a client’s account to fund the company’s day-to-day expenses.

Indifferent: Failure to consider the adverse effects of your actions or that of others. For example, having large exposure to a sector through poor capital allocation.

Benign: Do not cause harm and in principle support actions that impact positively on people but do little to make good things happen. For example, failing to report suspicious or unethical activities of firms to regulators.

Doing Good: Actively trying to improve the lives of people. For example, seeking the interest of clients by investing funds consistent with the objectives and needs of clients to exceed expectations. Asset Management firms should be guided by the fact that clients want a return on the money invested, and a return of the money when they make redemption requests.

Concluding thoughts

It is evident from the financial crisis that no firm is immune to insolvency. However, a disciplined approach in decision-making underpinned by a strong risk management framework and good governance culture will make a business thrive. Firms must resolve that, going forward, decisions made will be client-led through incorporating their needs and objectives; and also market-driven to ensure that capital is allocated only when there are opportunities to earn a return that is consistent with the accompanying risk.

Disclaimer: The views expressed in this article are solely those of the writer and do not necessarily represent those of the Institution he works for.

>>>The writer is a CIMA Fellow and an Investment Banker with 15years of experience in Fund Management. He can be reached on [email protected], 0276902032

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