(Editor’s Update on December 5, 2018: US fund managers are getting serious about striking back-up NAVs on their own. Milestone Group tells FinOps Report that it has nabbed two top-tier US headuartered fund managers to use its pControl Oversight platform to monitor their fund administrators and to strike back-up NAVs in-house, instead of relying on their service providers to do so in the event of an outage).
Published on May 11, 2018:
We need a backup plan — yesterday.
That is what fund management operations directors are quickly realizing when it comes to striking a net asset value. They can’t blindly rely on their administrators’ results because mathematical errors or, even worse, technological outages can happen. Then what? Potential regulatory fines, investor lawsuits and reputational risk can occur.
NAVs show the all-important value per share of exchange-traded or mutual funds that is made public at the end of the day. The US Securities and Exchange Commission and other regulators require fund managers to calculate correct NAVs. Although the regulatory agencies offer little guidance as to how they should do so, fund managers face regulatory fines if they they fail to publish correct NAVs, thus harming investors.
Fortunately, fund managers have options if their usual means of NAV calculation breaks down. Knowing which one to pick depends on how much work they want to do on their own, how much money they want to spend, and how concerned they are about what regulators think. Fund managers can rely on internal staff to create a back-up NAV from scratch, use a third-party technology provider, or depend on a full-fledged shadow accounting firm. Some fund administrators are also stepping up to the plate with do-it-yourself backup NAV platforms for all fund managers, not just their own clients.
Fund administrator and custodian Brown Brothers Harriman has just disclosed the launch of infoNAV which will offer fund managers a way to calculate a secondary NAV on their own. The bank’s announcement follows a series of client wins by rival fintech firms Milestone Group and Linedata. The Sydney-headquartered Milestone now has a total of 12 clients for its pControl NAV Oversight platform, including Artemis Management, Jupiter Asset Management, Generali Investments as well as the US-based Janus Henderson and Oppenheimer. The Paris-headquartered Linedata says that its Navquest platform has 15 clients, including TRowe Price and John Hancock Investments.
The interest in backup NAVs isn’t all that new. Although the well-publicized snafu experienced by BNY Mellon took place in late summer of 2015, it is apparently still fresh in the minds of US fund managers. At the time, BNY Mellon’s NAV engine –SunGard’s InvestOne — could not calculate NAVs for several days, leaving BNY Mellon to do so manually, say fund managers. About 66 fund complexes were affected by the problem, which started on August 22, 2015 and was solved on August 31.
“The main factor in promoting backup NAVs in the US is regulatory attention and the increasing awareness of fund boards and treasurers of their responsibility to ensure accurate NAVs in the face of a service provider outage,” says Milestone Group’s Executive Chairman Geoff Hodge who has relocated to Boston to become the president of Milestone’s North American operations as part of a management overhaul. Hodge’s previous role as Milestone’s chief executive officer will be assumed by Paul Roberts, Milestone’s head of Europe, the Middle East and Africa.
The UK’s decision to exit the European Union has also prompted European fund managers to independently oversee any third-party service providers, says Hodge. In the case of NAVs, that oversight has now extended into the category of validating a fund administrator’s NAV or creating a secondary NAV.
Shouldn’t fund administrators have their own backup plans for striking NAVs in case of a business disaster? If they do, they aren’t willing to talk about them. BNY Mellon wouldn’t respond to FinOps’ questions about any changes it made to its resources for NAV calculations after its 2015 snafu. “It’s a non-issue,” another custodian bank told FinOps Report.
However, as evidenced by the number of well-known fund management firms that are using Milestone Group and Linedata’s platforms, fund managers aren’t taking fund administrators at their word. “Fund administrators tell us that they have backup plans, but we can’t take any chances,” says one operations manager at a fund management firm. It all comes down to insurance, rather than assurance, insists Hodge.
How to Back Up
Creating a secondary NAV goes a step further than simply validating that a fund administrator’s NAV is accurate. Backup NAVs also come in two flavors. “An indicative NAV could also be created by validating the previous NAV and incorporating market events into the new calculation,” explains Tony O’Driscoll, Linedata’s director of sales and relationship management for North America.
However, some fund valuation experts tell FinOps taking this easy synthetic approach isn’t always the best choice. It might not be accurate enough. O’Driscoll says that the larger the fund manager the more likely it will want to do the backup NAV calculation from scratch. Milestone Group and Linedata’s platforms can help fund managers generate both indicative and contingent NAVs. Their methodologies differ. Linedata’s contingent NAV is calculated on the same fund accounting platform used to produce primary NAVs, while Milestone’s contingent NAV depends on mathematical algorithms which use the last known NAV along with other data. A full-blown fund accounting process is unnecessary, says Hodge.
Given that fund managers are ultimately held accountable for correct NAVs, why don’t they create back-up NAVs on their own using their own staff? Independent third-party oversight is critical to the NAV process, says Hodge. Fund managers want to show regulators they are fulfilling their fiduciary obligation to ensure a correct NAV by relying on external unaffiliated help.
There is also plenty of operational work — hence cost– involved when verifying a fund administrator’s NAV or creating a brand new one. The laundry list of tasks includes reconciliation of holdings, transactions and corporate actions with the records of fund administrators. Then comes validating data such as prices, holdings, corporate actions and expense accruals. Validation involves applying a set of movement and tolerance checks to ensure that results including the NAV itself are within an expected and acceptable range.
As a result, doing all of the work in-house can be far more expensive than using a third-party technology provider, claims Hodge. The same applies to using platforms offered by fund administrators — such as BBH’s InfoNAV, he believes.
BBH declined to comment for this article, but in a statement announcing the launch of infoNAV the bank touted the merits of the platform. InfoNAV enables a fund manager’s middle office and treasury teams to monitor a fund administrator’s creation of an NAV and to calculate a secondary or informational NAV if necessary. “InfoNAV also allows asset managers to compare the secondary NAV to the administrator’s NAV highlighting specific variations that may require review or risk mitigation,” says the statement.
Following One’s Shadow
Why not use a shadow accounting firm to create a backup NAV? Shadow accounting can also be expensive, agree Hodge and O’Driscoll. It involves replicating all aspects of the fund accounting process which is overkill for fund managers wanting only backup NAVs. Linedata Gravitas, a subsidiary of Linedata created last year through Linedata’s acquisition of Gravitas, offers shadow accounting to hedge funds and mutual fund complexes.
Shankar Iyer, chief executive of Viteos Fund Services, a Somerset, New Jersey-headquartered firm offering shadow accounting for hedge fund managers, insists that shadow accounting is well worth the extra cost. “The fund manager can produce an investment book of record (IBOR) which includes far more data than is likely held by the fund administrator,” he explains. Having an accurate view of positions and investable cash as well as any intra-day changes to a portfolio due to trading activities, corporate actions, and collateral management requirements can help fund managers make more informed front and middle office decisions, affecting cash, counterparty and expense management.
Although only hedge fund managers have embraced shadow accounting services so far, Iyer predicts that mutual fund managers will soon follow suit. Rather than relying strictly on licensed IBOR platforms, traditional fund managers will also turn to third-party players, he suggests.
Fund operations managers can always build their own IBOR using licensed platforms, but relying on a third-party allows them to scale more quickly and reduces the possibility of an inflated NAV, says Iyer, whose firm is expanding into the mutual fund arena.