3rd Party AIFMs and substance - risk management for UCITS and AIFs, not quite the same
3rd party UCITS managers deciding to expand their services and act as well as 3rd party AIFM are confronted to the challenge of conducting a robust risk management function.
As the scope of eligible financial instruments in the UCITS regulation has evolved over time, the 3rd party UCITS managers have had to cope for a while now with assets that are not quoted on an active market. However, the restrictions put on such eligible assets regarding their share in the portfolio of any UCITS, their valuation in terms of independence of the valuation process, their accuracy and timeliness have made possible to run relatively low cost and traditional approaches such as the historical method (using past observed prices or valuations to deduct a Value-at-Risk) or the parametric method (assuming a normal distribution of the valuations/prices with an observed variance/covariance matrix). The use of a tracker duplicating more or less the behaviour of the non-listed financial instruments can even be considered.
However, it turns out that when becoming 3rd party AIFM, players are confronted with non-listed assets whose characteristics, valuation processes and frequency of reporting direct a robust risk management function towards more sophisticated modelling with the use notably of the Monte Carlo method.
When 3rd party AIFMs embark on this journey, they usually rely on traffic light indicators built on qualitative questions regarding the exposure to market risk, credit risk, liquidity risk, counterparty risk and operational risk. The question is then how to move from this starting point to the production of more powerful risk indicators such as Value-at-Risk, cash flow projections and expected returns to both provide substance and help their clients in marketing and normalizing their products in the portfolio of investors.
Through its long experience in risk management for closed ended funds consisting of illiquid assets such as positions in unlisted companies or real assets, LDSP is at the forefront and assists 3rd party AIFMs in making the difference for their clients.