LO 72.4: Describe criteria that can be evaluated in assessing a funds risk management process.
A proper risk management process should contain an assessment of the following areas: risk, security valuation, portfolio leverage and liquidity, tail risk exposure, risk reports, and consistency of the fund terms with the investment strategy.
Assess the applicable systematic risk factors (i.e., regular market risks common to most or all funds) and unsystematic risk factors (i.e., risks specific to the manager, fund, or strategy).
Determine whether written policies and procedures exist regarding measuring and
Determine whether a risk committee exists that would receive such measurements. If so,
how often are they reported?
Evaluate the extent of the risk management culture among the various types of
employees. For example, how actively involved are employees with managing and mitigating the firms risks on a day-to-day basis?
Assess the information technology resources used to quantify the risks. For example,
are they reliable and do they measure items consistently between traders and portfolio managers? Identify the existence and structure of any risk models. What are their inputs and assumptions? Have the models been tested and are they robust?
Identify the proportion of fund assets that are objectively valued through reliable market prices versus those that are more subjectively valued by the broker or through simulation.
Examine the independence of valuations. Is valuation performed by the fund
administrator (generally more independent) or by the fund manager (generally less independent)?
Determine if prices may be overridden for valuation purposes. If so, by whom? Is there
documentation or an approval process?
Portfolio Leverage and Liquidity
Assess the sources of leverage as well as the current and historical levels of leverage. Calculate the current level of liquidity and observe how it has changed over time. The
current level is especially relevant because of the impact on portfolio investment capacity and whether it can take on more investment capital.
Within a stated investment strategy, excessive leverage and/or illiquidity could generate
actual returns that are significantly different than expected (i.e., no longer comparing apples to apples), thereby requiring an adjustment in expected returns.
2018 Kaplan, Inc.
Topic 72 Cross Reference to GARP Assigned Reading – Mirabile, Chapter 12
Exposure to Tail Risk
.Analyze information about the fund to conclude whether the funds return distribution possesses skewness or kurtosis.
Discuss the possibility of tail risk with the manager and determine whether the manager
has sufficiently mitigated the risk or whether further action is required by the investor.
Review risk reports prior to investing in the fund. Investors should receive these risk
reports on a regular basis (e.g., monthly, quarterly, annually) whether they are prepared in-house or by a third party.
Analyze key risk metrics and compare them to other similar funds for benchmarking
purposes and for determining if any unusual risks exist in the fund.
Consistency of the Fund Terms with the Investment Strategy
Examine the general fee structure of the fund and determine whether it is consistent with
similar funds. Identify the existence of any additional fees after a specific threshold (e.g., high-water mark, hurdle rate).
Evaluate whether high fees are being paid to managers in search of market alpha (fair) as
opposed to beta (unfair). Identify the existence of any limitations or blackout periods on redemptions.
O pe r a t io n a l D u e D il ig e n c e