Mutual Fund Stability Rating

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.

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.

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.

Score       WAM

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 2         4 Years

0 to 1         Above 4 Years

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 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 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

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

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

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 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

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 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 

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 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.