ALFI UCITS IV implementation project – KID Q&A Document

e stored, provided that the practitioner is able to compute them again if it is required in the future to demonstrate howit found the SRRI.CESR's methodology also contains indications as to what data are relevant to the computation. For example, para2(a)(ii) of Box 6 says that "the reference asset allocation of the fund at the time of the computation" are relevant, andwe think that it should be retained.It may not be strictly necessary to retain computed data but there may be circumstances in which it may be worthwhileto retain the results of key computations – the "milestones" that were passed as the computation progressed – toprovide a credible audit trail which could be sample-tested without the need for expensive re-computation from firstprinciples. For example, we think that it would be a good idea to retain the weekly or monthly SRRI result (actually, thevolatility result), which delivers the number that used in the "sliding window" test, and which determines what SRRIvalue should be published in the KID. There may be other examples and the practitioner must decide which to keep,taking into account the benefit of the audit trail, the cost of re-computing the SRRI from first principles, the likelihoodthat it will be asked to do so, and the limitations on the practicality of creating useful audit logs for complex calculationson potentially very large data sets.Q. May the SRRI be simulated using a composite benchmark?A. Yes. Particular care should be taken with absolute return and total return funds to ensure that the compositebenchmark is properly adjusted to reflect the variable allocation of the fund to its target asset classes with respect totime, and that the fund is not inadvertently treated as a market risk fund by virtue of its relationship with thebenchmark. Practitioners should keep a record of the basis upon which a composite benchmark was composed andadopted and how it was used to simulate the SRRI (CESR/10-673, page 6).Q. May a fund's correlation with a benchmark be used as grounds for deciding that it is a market risk fund,and are there criteria to say what degree of correlation is acceptable?A. CESR’s guidelines on the methodology for the calculation of the SRRI in the KIID (CESR/10-673) providedefinitions for different types of fund. The definitions do not set criteria for testing the correlation of fund andbenchmark as an aid to deciding whether the fund is a market risk fund by virtue of the fact that it is or will besufficiently invested in some "pre-determined segments of the capital market" (i.e., the segments represented by thebenchmark); that is something that the practitioner must decide.We think that a combination of quantitative and qualitative techniques may be used to establish the suitability ofbenchmarks for all types of fund. They may take into account the degree of freedom granted by the investmentmanagement mandate. For example: how much the fund may be over- or under-weight the sectors of the benchmark,or how the beta of the fund and the benchmark compare. There are many other possible criteria. We think that it isimportant that the classification of a fund according to CESR's methodology should be objective, defensible, likely tobe persistent and be documented. The practitioner should perform periodic tests of the classification and, whererelevant, the benchmark's suitability for the fund.Q. If there is more than one suitable benchmark for a fund, how should the most appropriate one be chosen,particularly when simulating the SRRI?A. As with the previous question, we think that a combination of quantitative and qualitative techniques may be used tochoose the most suitable benchmark. The practitioner may wish to use the techniques that it considers most useful tothe objective of selecting the benchmark that best describes the specific risk of the fund.Q. If a fund does not have a benchmark (for example, in the specific case of a market risk fund which has noidentified benchmark), how should the practitioner choose a benchmark with which to simulate the SRRI?A. It is not always necessary to choose a benchmark. CESR/10-673 also permits a "representative portfolio model [or]asset mix".Q. The explanatory text to Box 4 at page 10 of CESR/10-673 (market funds) specifies that “ongoing costs”should be accounted under certain circumstances. Which costs have to be considered and when can wejustifiably expect them to affect volatility estimates to a material degree?A. The term “ongoing costs” complies with the notion of “ongoing charges” as used in Art 10 of EU Regulation 583/10and CESR’s guidelines on the methodology for calculation of the ongoing charges figure in the KIID (CESR/10-674).Management companies should analyse the cost impact on volatility estimates and provide a definition of “materiality”.We think that only in the case of exceptional cost structures benchmark returns will need to be adjusted to account forongoing costs.ALFI KID Q&A, Issue 1314, 11 April25 September 2012 Page 42