When a patient experiences a fever, the usual practice is to try and find the underlying cause. That is, the fever is treated as a symptom and an investigation conducted to find the illness causing the fever.
Applying this analogy to unit pricing, a unit pricing incident can often be a symptom of an underlying issue within an investment organisations operating model. Unfortunately, the usual practice of firms is to address the direct issue, often ignoring the underlying problems that contribute to the unit pricing issue in the first place.
Why are unit pricing exceptions a useful diagnosis tool?
Unit pricing is often referred to as the ‘pointy end’ of an investment Firm’s (Funds/Schemes/Investment Options) operational processes. Far from being a simple mathematical process, unit pricing not only requires an accurate valuation of investment assets but also necessitates accurate and timely processing of member transactions and appropriate application of accounting policies, such as the recognition of taxation accruals. In short, nearly all business functions need to be ‘on their game’ to ensure that unit prices are accurate. For instance, the following business functions need to ensure that:
Investment operations – investment trades have been captured and matched with counterparties
Investment valuations – all assets have been valued correctly and in accordance with the Firms policies
Investment accounting – all assets have been appropriately valued and in accordance with the Firms investment policies
Member administration – all member transactions have been processed in accordance with cut-off times
If any business function gets it wrong, chances are it will show up in the unit price as an exception and can be used as a tool to alert management on an underlying issue that requires further evaluation.
Converting unit pricing analysis into a diagnosis tool
So how can a Firm use its unit pricing as a diagnosis tool? Firstly, management should understand the end to end process that is used to derive the unit price. Obtaining full visibility of these processes allows the Firm to gain an appreciation of all critical business processes that ultimately derive the unit price. This is particularly useful for processes that have been outsourced to a 3rd party, such as a Custodian for a Fund Administrator. By documenting the operation of these processes, the overall control environment can be assessed and appropriate rectifications made. We refer to this step as the initial unit pricing health check.
Once management are satisfied that the business processes supporting unit pricing are operating effectively, these can serve as the baseline for future operations.
The next step is to develop a unit pricing dashboard.
This tool compares the ‘expected’ unit pricing return (based on the relevant benchmark) to the actual unit price and seeks to provide an attribution of the differences. Where the difference is not explainable this can help alert management on potential underlying issues that likely require further investigation. The following summarises an example dashboard that could be used to diagnose a unit pricing issue.
In the above example, the Growth Fund and the US Equity Fund have outperformed the benchmark, requiring further analysis. The Growth Funds outperformance can be explained by positive market movement and a tax adjustment. The US Equity Fund has 0.25% of its return unexplained, necessitating further analysis. In this scenario, it is entirely possible that the unexplained return of the US Equity Fund highlights an issue on an underlying operational process that requires attention.
So what should be done?
Rather than being a non-value add operational overhead, unit pricing can help diagnose underlying issues within your Funds operation. By adopting a robust review process, firms can use the results to identify systemic issues in their operations to drive overall improvement of process and controls. After all, by calculating unit price a Fund is essentially taking its own temperature. Why not use it to help improve the quality of its operations?
Shoreline is a specialist asset and wealth management consulting firm with offices in Singapore, Sydney and Melbourne. We have developed robust tools to help investment firms to review their unit pricing operations. Contact us to see how we can assist in improving your unit pricing processes.
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