Mutual Fund Stability Rating Introduction Mutual Fund is a collective investment scheme that pools funds of its investors and invests such funds on behalf of those investors. In Ghana Mutual Funds and Unit Trusts are generally categorized according to their investment objectives
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Beacon Ratings Financial Sector
Mutual Fund Stability Rating Introduction Mutual Fund is a collective investment scheme that pools funds of its investors and invests such funds on behalf of those investors. In Ghana Mutual Funds and Unit Trusts are generally categorized according to their investment objectives and their investment policies. Some mutual funds focus on equity shares, bonds, money market instruments, real estates or other securities. Typical types of mutual funds and unit trust in Ghana include:Fixed income funds
Mutual Fund Stability Rating
Introduction
Mutual Fund is a collective investment scheme that pools funds of its investors and invests such funds on behalf of those investors. In Ghana Mutual Funds and Unit Trusts are generally categorized according to their investment objectives and their investment policies. Some mutual funds focus on equity shares, bonds, money market instruments, real estates or other securities. Typical types of mutual funds and unit trust in Ghana include:
Fixed income funds: These funds invest in longer-term fixed income securities such as bonds, notes, corporate debt, fixed-deposits, debentures and longer-term government securities. They may also include some money market instruments but largely do not include equities.
Money market funds: These funds invest in instruments (mostly loans) which mature within one year. These have low-risk, short-term securities such as treasury bills. It has a primary objective of protecting capital rather than seeking growth.
Equity funds: These funds invest mainly in equities (shares). These funds have long-term growth objectives.
Real estate investment trusts: These funds invest in real estate either private accommodation or commercial properties.
Balanced funds: These funds invest in mixture of fixed income, equity, money market instruments and any other strategies to try to achieve both growth and short-term protection of capital.
Ethical funds: These funds deliberately exclude certain industries and sectors (e.g alcohol, fossil fuel, tobacco) which for moral grounds are not invested into even if they stand to gain by investing in them.
Mutual funds stability rating
Stability Rating is assigned to a portfolio of assets i.e. mutual fund, that could be made up of fixed-income funds, money market funds, equity income funds and aggressive income funds.
Beacon Ratings’ mutual fund stability rating is an opinion on the relative stability in a fund’s return. The rating is designed to provide investors with a simple to use indicator for evaluating the sensitivity of a fund’s net asset value to a combination of risks.
Rating Criteria
Credit risk
Overall risk assessment: The assessment of a fund’s credit risk aims at forming an opinion as to the fund’s overall exposure to this risk. The opinion is based on review of various factors:
fund’s investment policies regarding credit risk exposure towards various market segments
individual and cumulative credit quality of the investment portfolio
diversification of assets across investment types and issuers
weighted average maturity.
Market segment: The fund’s exposure to market segments is analyzed to estimate the risk inherent in the investment portfolio. High rated funds have predominant exposure to low risk segments - government securities - and low proportion towards high risk avenues - corporate securities.
Non-performing assets:The asset composition of the portfolio will be reviewed in terms of:
non-performing as against fund size
under-restructuring assets as against fund size
fund’s performing assets as against current and future losses
Concentration risk:The concentration risk in the portfolio is established by analyzing the diversification across investment types and issuers. Fund portfolios are subject to additional risk when they are highly concentrated in a specific industry.
Clearly articulated and documented policies and procedures to ensure compliance with stated portfolio diversification objective.
Diversified portfolio to minimize exposure to single issuer, sector, security or market segment.
Weighted average maturity (WAM):The weighted average maturity of the investment portfolio is analyzed to capture time horizon over which the portfolio is exposed to risk. Portfolio having longer WAM is more vulnerable to credit risk in comparison to portfolio with lower WAM. The table below measures the fund’s ability to maintain the threshold.
ScoreWAM
9 to 10 45 Days
8 to 9 60 Days
7 to 8 90 Days
6 to 7 180 days
4 to 6 2 Years
1 to 24 Years
0 to 1 Above 4 Years
Market risk
Market risk is the connection of variables affecting market value of the underlying portfolio. Market value can fluctuate due to a number of variables including:
Interest rate: measures the fund’s sensitivity to shifts in the yield curve. Duration is a useful tool for quantifying a fund’s exposure to interest rate risk. In general, the longer the duration, the more susceptible the fund is to interest rate movements.
Operating environment.
Volatility in prices of Term Finance Certificates (TFCs)
Liquidity risk
Liquidity of fund’s portfolio is critical for maintaining a stable net asset value. Liquidity refers to the speed at which security can be sold for approximately the price at which the fund has it valued. Securities which are less liquid are subject to greater price variability, and can significantly impact the net asset value in times of major redemptions. More liquid investments present lower risk, as it is more amenable to accurate pricing on a daily basis and support the fund’s ability to correctly measure net asset value. Factors assessed are:
Types of investments in the portfolio
Maturity structure
Secondary market liquidity
Operating efficiency
Operating activity and efficiency are assessed using financial ratios such as:
Cost of production per unit compared to competitors
Stock turnover
Debtors’ collection period
Creditors’ payment period
Turnover to total assets
Current capacity utilisation
Operating expense to income
Sensitivity of key drivers, selling prices and input costs
Redemption: Effective management of investment liquidity is to accurately monitor and anticipate subscription/redemption activity. Unexpected large redemptions have a direct influence on the fund’s market risk exposure, as they could lead to liquidation of investments at below their fair value to meet redemption requests.
Composition and characteristics of each fund’s unit holder’s base
Proportion of top investors in total net assets of fund
Effectiveness of tracking and anticipating major redemption activity
Extent of investment in liquid assets as a percentage of net assets
Historical returns’ volatility
The funds variability in returns is gauged on standardized basis through:
Coefficient of variation - standard deviation of monthly returns/average monthly return
Investment policies and process
The policies and processes developed to meet investment objectives including:
Organizational structure
Internal controls
Risk management
Reporting systems
Level of risk tolerance
Harmony in fund’s stated objectives and investment philosophy
Asset mix and investment strategy
Investment policies
Regulatory compliance
The process in place to ensure compliance with regulatory requirements. Compliance allows for reducing risk due to a loss from regulatory proceedings as well as reputational loss.
Level of compliance with regulatory requirements
On-going and past regulatory discussions
Pending/past regulatory non-compliance
Statutory compliance reports
Business model
The business model assessment is to determine the stability of investment manager’s business, inherent risks that may threaten the viability of operations, market opportunities, and robustness of business models to sustain competitive market dynamics and unstable markets. Factors assessed include:
Products
Target markets
Nature of clients
Distribution channels
Strategic alliances with other providers
Portfolio management process
Fund manager’s processes, controls and monitoring systems’ responsiveness to changes in client needs and capital markets conditions are critical elements for measuring portfolio management quality. Well-developed investment policy is fundamental to portfolio management risk control and disciplined investment management. The investment policy determines the asset classes that can be represented in the portfolio, allocation among asset categories and rebalancing limits for allocations. The investment policy specifies constraints and restrictions on assets, such as liquidity, marketability requirements, and diversification concentrations. The following factors are assessed:
Portfolio management processes
Investment infrastructure scalability
Investment policy guidelines
Investment policy implementation
Performance measurement and reporting
Composition of investment committee
Investment committee decision making process
Investment research
Risk management process
Risk management processes, practices and regulatory compliance are assessed. Fund manager’s framework for identifying and measuring risks including market, operational, credit and liquidity risk and personnel responsibilities towards risks are also assessed. Risk estimation techniques such as value at risk, default risk analysis etc. and processes employed to monitor and control risks including scenario analysis, stress testing, internally defined limits for exposures are assessed. The quality of oversight provided by board of directors, risk committee, management information, regulatory ccompliance and internal audit function are assessed.
Risk identification
Risk measurement
Risk monitoring
Risk control
Risk mitigation
Regulatory risk compliance
Internal audit role
Fund performance
The fund performance and track record of a fund manager provides insight into its capability to deliver a consistent and repeatable performance and to maintain competitive fund performance vis-à-vis its peers and established benchmarks with similar portfolio objectives and risk tolerance standards. Risk-adjusted returns and performance attribution analyses provide greater insight into the relative performance of investment portfolios.
Portfolio rates of total return
Portfolio total return breakdown and attribution
Achieved portfolio objectives against established benchmarks
Portfolio risk-adjusted returns
Financial performance
Financial performance of fund managers provides information about financial strength to remain well-resourced to support business growth and adapt to changes in its operating environment and regulatory requirements. Sound financial performance and cash flow position and capital buffers over and above the regulatory minimum capital situates the fund manager to effectively deliver on clients’ mandates. Factors assesses include:
Growth of funds under management
Operating margins
Return on equity
Return on assets
Cost to income
Transparency and disclosures
Disclosure of cost structure, portfolio composition and method for computing net asset value (NAV) are key to achieving transparency with investors. NAV is the worth of investors’ net asset at a particular date, thus an important indicator of investment performance, which should not only be consistent with regulatory guidelines, but should also conform with industry best practices. Beacon Ratings assesses the following key factors includes:
Disclosure of cost structure
Disclosure of assets/entities invested
Disclosure of portfolio composition
Disclosure of method of calculating net asset value
Investor service quality
The promptness in processing sale/repurchase requests, responding to investor grievances, proper and timely crediting of investment returns such as dividends and bonuses provides confidence in investors.Furthermore, fund manager’s marketing, distribution and clients service activities are important indicators of clients’ service standards. The use of multiple distribution channels maximises sales potentials and increases funds under management.Key factors include:
Promptness in processing sale
Promptness in repurchase requests
Response time to investor grievances
Proper crediting of returns on investment
Timely crediting of returns on investment
Distribution channels
Quality of service delivery
Corporate governance
Governance structure in terms of competence and strategy implementation to grow and defend clients’ investments.
Board independence
Board committees
Board practices and track record
Board oversight responsibilities
Support for senior management
Board regulatory compliance
Management quality
Senior management’s capacity to effectively execute strategies, investment objectives and adhere to stated policies ultimately depends on the management’s experience and quality of support systems
Management stability
Management track record
Statutory compliance reports
Management pro-activeness
Line management’s track record
Management’s appetite for risk
Senior management succession planning
Rating scale and interpretation
Imported table
Rating scale
Rating scale interpretation
MF S1
Exceptionally strong capacity to maintain relative stability in returns and possesses negligible exposure to risks.
MF S2
Very strong capacity to maintain relative stability in returns and possesses low exposure to risks. This capacity may, nevertheless, be more vulnerable to changes in circumstances or in economic conditions.
MF S3
Fund with stable performance generally in line with its peers with strong capacity to respond to future opportunities or stress situations.
MF S4
Adequate capacity to maintain relative stability in returns and possesses high exposure to risks. This capacity may be impacted adversely by changes in circumstances or in economic conditions.
MF S5
Low capacity to maintain stability in returns and possesses very high exposure to risks.
MF S6
Very low capacity to maintain stability in returns and possesses very high exposure to risks.
Rating outlook
Rating outlook assesses the potential direction of mutual funds’ stability over the intermediate term, typically over a one to two years’ period. Ratings from MF S2 to MF S5 may be modified by a positive (+) or negative (-) suffix to show its relative standing within the major rating categories.
Imported table
Positive
Indicates a rating may be raised
Negative
Indicates a rating may be lowered
Stable
Indicates a rating is likely to remain unchanged
Developing
Indicates a rating may be raised, lowered or remain unchanged