Operational Due Diligence, Multi-Asset Credit

Client-Specific Concerns

A reinsurer was looking to increase its allocation to multi-asset credit and took the opportunity to review (and potentially replace) its incumbent manager.

With two finalist managers—the incumbent and one other—the investor sought additional specialist support from bfinance to evaluate them from an operational perspective. While there were no specific concerns in relation to the existing manager, the client felt it prudent to ensure that their operating environment remained appropriate while the second manager was also being evaluated.

Outcome

• Producing in-depth analysis: Comprehensive, structured evaluations were produced for both managers, based on: their responses to strategy-specific due diligence questionnaires; other documentation (compliance manual, order execution policy, best execution policy, trade error policy, valuation policy, business continuity plan, cyber security policy, cyber incident response plan, internal controls report and more); interviews with key personnel.
• Flagging the treatment of trading errors. One of the managers – a very well-established firm (AuM >£50 billion) – had a Trade Error policy that was found to be inconsistent with market practice for a liquid market credit strategy. There was ambiguity as to whether an investor would be compensated for losses resulting from a trade error that was caused by the manager. Further analysis revealed that the firm implemented a materiality threshold and applied a 12-month lookback window when netting gains and losses related to trading errors. The bfinance team was uncomfortable with all three points, shared views with the manager in order to encourage improvement and advised the investor that this risk could be specifically addressed within the Investment Management Agreement.
• Encouraging other improvements: Certain other areas for improvement were identified. For example, one manager made limited use of recurring background checks on its staff. One manager had not conducted a crisis management exercise since 2018 and the scope of its framework was narrow relative to our view of best practice (leveraging external threat intelligence to define scenario planning in relation to cyber security threats, business continuity events and non-operational scenarios such as green washing and insider trading).