How to protect clients when times are good

Dropping in to speak to Cayman’s investment professionals during a whirlwind tour of the Caribbean and South Eastern US, Philip Lawton of the CFA Institute and Head of the CIPM Programme gave an interesting presentation on the importance of protecting investors in good times. Business Editor Lindsey Turnbull was in attendance and reports. Second part in a series.

Analysing strategies
The CFA Institute teaches that investment managers have an ethical obligation to disclose strategies and their attendant risks and that CFA members and candidates were under an obligation to abide by this code.
“It therefore follo ws that investors have a corresponding right to know the strategies and risks associated,” Lawton said.
This created a difficult position for hedge fund managers who traditionally exploit price inefficiencies as part of their strategy and who are therefore keen to keep this to themselves, lest the competition learn about what is making them money and price them out of the market.
To illustrate this age-old issue, Lawton then quoted Herman Melville (the author of Moby Dick) in his book The Confidence Man, published in 1857:
“How is the gain made?”
“To tell that would ruin me. That known, every one would be going into the business, and it would be overdone. A secret, a mystery–all I have to do with you is to receive your confidence, and all you have to do with me is, in due time, to receive it back, thrice paid in trebling profits.”
Lawton said it was important to ensure that clients’ money was not put at risk by investing it with investment managers with only vaguely disclosed strategies.

Passing the philosophy test

Investment philosophy should be comprised of a set of beliefs which regard the pricing mechanism, the investment managers’ competitive advantage and should also look at just how the manager intends to produce Alpha.
Lawton said the philosophy test should not be an easy one to bluff through.
“If they cannot get past the marketing slogans they do not deserve to be hired,” he confirmed.
Those who ought to be confirming that the manager’s returns are real should be public accountants, custodians and GIPS verifiers, not the investment manager themselves. “Investors need the assurance from independent service providers, not the manager,” Lawton stated.
In particular Lawton said that the GIPS test, while not an audit and not able to predict investment results, was a good indicator that the fund was being properly run.

Keeping control
Lawton went on to say that the financial service professional ought to get some feel for the manager’s internal controls, such as business continuity plans should a disaster befall the fund.
“Once selected the manager needs to be monitored in a serious and disciplined fashion, not only to detect fraud but also to ensure that they are sticking to the investment parameters of the fund,” Lawton said.
He said that even minor investment policy violations were worth noting because they might be a sign of a breakdown in controls at the investment manager.
“Organisation controls go to the heart of the issue and are vital to watch because they can result in a loss of consumer confidence if they breakdown,” Lawton confirmed.
Regulatory actions were another common sense way to monitor the investment manager. “Keeping an eye out for actions affecting an investment manager in control of funds is a relatively easy process in the US,” he said. “You simply go on to the SEC website and enter the manager’s name for any recent actions.”
Lawton summed up by saying that investment professionals needed to be vigorous and ethically grounded as well as tough-minded to successfully protect clients’ funds.
“It’s up to everyone to protect clients, especially when times are good,” he said.


From left, CISPA Treasurer Charles Bolland, Philip Lawton and CFA Society of the Cayman Islands Director Mark Fagan