Fund managers bought products they didn't understand, survey finds

A recent survey by auditing firm KPMG reveals a chasm in the level of derivatives and risk management knowledge at global fund and investment managers.

The survey included mainstream fund managers, as well as institutional investors, private equity, real estate and hedge funds globally.

According to the results, 40% of mainstream fund managers surveyed said they had bought products for which they had no framework to assess risk.

Meanwhile, 20% of mainstream fund managers admitted to having no in-house specialist with relevant experience of the derivatives or structured products in which they invested. Among institutional investors who invested in derivatives or structured products, the figure was even higher, at 32%.

Fund managers might not have been identifying and tackling the right kinds of risk, the survey suggested. Just 41% of those mainstream fund managers surveyed thought their principal measure of risk reflected the majority of risk an investment firm took. Perhaps a result of recent concerns over the adequacy of risk measures such as value at risk, only 6% believed their measures represented the actual risk of loss.

Only 42% of mainstream fund managers said they could completely quantify their exposure to complex instruments, while 24% said they could completely quantify the risks arising from it.

The skills of staff at fund managers had “to some degree” failed to keep up with the growing sophistication of the industry, the survey’s authors said.

Confidence in external assessments of risk from either dealers or rating agencies also appeared to be low across all investment firms. Thirty-four percent of mainstream fund managers and 50% of institutional investors said they had been sold a product whose risk was understated by its originator.

After the battering taken by rating agencies for their underestimation of the risks posed by US subprime mortgage portfolios, just 35% of all respondents agreed rating agencies provided an accurate assessment of risk. A meagre 1% thought ratings were “very accurate” in predicting defaults.

Despite the apparent gap in derivatives know-how at mainstream fund managers identified by the survey, 61% of those questioned were using them. Of those with at least $10 billion in assets, almost a third said they used derivatives to a “major extent”. Among all investment firms surveyed, 57% used derivatives.

This proportion looks set to increase. Over the next two years, 39% of participants globally said they would increase their use of derivatives, while just 5% said they would reduce their derivatives use. Forty-seven percent said there would be no change in their derivatives use.

However, there appears to be little appetite for collateralised debt obligations following the recent credit meltdown. As little as 9% of respondents were looking to increase their exposure to collateralised debt obligations, with 17% of all respondents to the KPMG survey eager to pull back from the asset class.

The company quizzed senior executives at 333 investment management firms. Of them, 31% were based in North America, 29% in western Europe and 23% in the Asia-Pacific region.

See also: Evidence of risk tolerance returning, says BIS
Weather derivatives trading increases 35% year on year
CDS market soars but equities shrink in late 2007
Corporates shy away from FX e-trading
UK pension funds not hedging as much as expected

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