Operational Due Diligence

Due diligence is the process of analysing the philosophy, people and processes of an investment manager to ensure it is capable of performing the functions for which it has been appointed. ODD focusses on the operational capabilities of these investment operations related functions.

The ODD process provides insight to the risk culture and approach of the investment manager. The ability to identify, measure and manage ALL risks while applying its investment strategy is integral to the process. Processes may be wide ranging and vary from the ability of the manager to stay in business and withstand a serious event, to manage and direct its own service providers, to the risk control framework and culture that exists within the manager’s operations.

More information about APRA’s initial 2014 expectations of funds in relation to ODD can be viewed here. Their 2018 update can be viewed here.

The ODD review is not a ‘tick the box’ exercise. There is expected to be a strong advisory element to an ODD report which provides insight to whether a manager is capable of fulfilling its operational obligations and that these operations are in line with industry practice. The expectation is that an ODD review also includes third party descriptions and observations of key processes and systems, and relevant evidencing and testing.

ODD must include critical areas of the investment manager’s activities that are integral to the provision of services to funds, including an understanding of the functioning of the investment operations, accounting, compliance, risk management, IT systems and processes and the management of service providers.

An ODD report will comment on the ability of the fund manager’s operational processes to meet future obligations and targets outlined in an IMA or Trust documentation. Such opinion is expected to be based on an analysis of data used to verify systems and processes, desktop analysis and an onsite visitation program. To carry out the review and make these observations, it would be expected that the ODD reviewer team would include relevant experience relating to the operations of investment managers.

Areas are identified in the Guidance Note may not be exhaustive, as a range of operational events may vary according to asset class, investment-style and geographic region.

The AIST ODD Guidance Note can be viewed here.

The Operational Due Diligence Fact Sheet can be viewed here.

1. Using the “Investment Manager” report as a base upon which a superannuation fund does their bespoke analysis, time and resources are saved by reducing the quantity of engagement necessary and allowing focus on a specific aspect of a manager’s process that may need attention.
2. A superfund, in many cases, has access to a manager’s ODD report prior to appointment and therefore has more information on which to base a decision. This should lead to mandates being funded more quickly - a benefit to both investor and investment manager.
3. The practical implication of all superfunds requesting duplicative work from a very limited field of ODD providers is eliminated.

Australia is not alone in seeing the merits of the “Investment Manager” ODD model. AIST is aware of two global providers expressing support for the model. It is encouraging to receive this explicit support as global providers have been wedded to an alternative method (the investors pays model), but understand the benefits and efficiencies of the approach introduced to the Australian market.

It is also encouraging to have the support of most of our members who have resolved to follow the GN to varying degrees, depending on internal resourcing.

AIST continues to work diligently to improve the landscape for all members ensuring greater efficiency and cost savings across the industry.

The AIST model accepts that the responsibility of the assessment of the ODD review, with regard to their investment proposition, remains with the investor (the Superannuation Fund) which must be satisfied of the veracity and completeness of the report. It is anticipated that the investor can, and must, consider in depth any aspect of the assessment on which they might have concerns or questions. To this end, the GN is a complementary aid to the investor’s analysis of ODD risk.

AIST has issued a template letter for writing to investment managers regarding operational due diligence of investments. The template letter can be viewed here.

The Guidance Note has received widespread industry acceptance with at least one report received from all Australian based providers. About 100 global and Australian investment managers now use the Guidance Note, with the number continually increasing.

Most AIST members are supportive of the principles in the Guidance Note and have adopted the recommended model. The extent to which each fund relies on external reviews depends largely on internal resourcing and expertise.

In commenting on the Guidance Note and the resulted ODD questionnaire released by the Financial Services Council, APRA has said that “Both of these industry initiatives are expected to, over time, help to clarify expectations and assist in the standardisation of information and reports in relation to ODD across the sector”. APRA’s 2018 update on ODD implementation can be viewed here.

In developing the Guidance Note, AIST was conscious of the impracticalities of following the “owner-led” model. The time and costs involved in all AIST member funds all commissioning individual ODD reports on their managers would be significant. The totals number of reports required could exceed 2,500. This would a huge project that would require resources beyond those available in the Australian market.

A list of organisations that have completed an Operational Due Diligence report for an investment manager under the AIST model can be viewed here.

Any organisation seeking to be added to this list should contact AIST.