CPF Investment Scheme

 

Evaluation Criteria for Prospective Fund Management Companies for Inclusion under the CPFIS

The Central Provident Fund (CPF) Board has appointed Morningstar Research Private Limited (Morningstar) to assist with due diligence related to the inclusion of Fund Management Companies (FMCs) to manage unit trusts and investment-linked insurance products (ILPs) under the Central Provident Fund Investment Scheme (CPFIS). The information below, provided by Morningstar, is intended to let FMCs gain a better understanding of the criteria applied in the evaluation process. The due diligence activities conducted by Morningstar include an on-site interview with the FMC’s Singapore-based management team. The Morningstar Evaluation of the FMC focuses on several key areas:

1. Organisational Strength: Financial Strength, Ownership, Business Strategy, Corporate Culture, Recent Corporate Actions and Regulatory Issues.

Financial Strength and Ownership: Morningstar assesses the FMC’s financial strength, including factors such as whether the FMC is privately- or publicly-owned, how well-capitalised the business is both at the parent and local level, the company’s shareholding structure, and if the FMC is owned by a financial institution such as a bank or insurance company or is it an independent entity whose core business is in funds management. The soundness of the financial strength of the FMC typically has an impact on its ability to sustain the business over the long haul, build and retain a skilled team of business managers and skilled investment staff while providing a stable environment of portfolio assignments and fund the necessary information and trading infrastructures to support its business. Assessments of major shareholders’ commitment to the business including the FMC’s vulnerability to takeovers or mergers are also looked into at this stage. Business Strategy: Asset management is a business and all FMCs aim to grow their assets under management and profits at a good clip. Some FMCs achieve this by adopting a business strategy that specialises in just one asset class such as fixed income, yet others have built up expertise across many asset classes and investment styles. Regardless of the strategy adopted, the requirement for FMCs is to do this responsibly (i.e. delivering good value to investors by running funds in areas where they can deliver strong long-term performance). There are instances when FMCs attempt to gather assets quickly by rolling out new funds in areas where there's a lot of interest and marketing them heavily. Morningstar prefers the former as the latter tend to have little staying power and often burn investors who buy in near the peak of a trend. In addition, Morningstar examines the level of capabilities and resources the FMC has structured to support its Singapore operation as well as the FMC’s commitment to developing its business and servicing retail investors in Singapore. Manager Incentives and Corporate Culture: Funds are not run in isolation. If the FMC does not do what it takes to retain the best manager, he may leave before the investors of the fund have much of a chance to benefit. Furthermore, the corporate culture at a FMC reveals a lot about its strengths and weaknesses. Generally, FMCs that run into problems are often those where the marketing side of the group has a bigger voice in fund creation and management than the investment group. In short, it would be a red flag when pushing product becomes more important than responsibly stewarding assets. Other key items that Morningstar evaluates include how the FMC's management works to keep costs down for investors (if it does so at all) and how they evaluate capacity of their funds and if they do a good job of closing funds that are in danger of growing too large. Ignoring costs or capacity is another red flag. FMCs that are proactive and communicate openly with unitholders are viewed positively. Finally, Morningstar will also investigate recent corporate actions involving the FMC to assess their impact, if any, on its core investment operations. All FMCs are obligated to inform Morningstar of any imminent regulatory action involving its entities in any part or part of the globe. Details will be logged and Morningstar will make an immediate assessment of their impact on the status of the FMC’s products included under CPFIS.

2. Capabilities of Team & Level of Resources deployed globally and locally: Team size, structure, experience, track record and responsibilities.

Morningstar considers the fund manager’s experience, track record and philosophy, and looks to see if he has run similar funds in the past (this is especially relevant if his track record at the current fund is limited), and how he fared. Morningstar also looks at the FMC's research resources, including the depth and stability of the fund management team, the number of analysts at the manager’s disposal, their experience and the extent of their stock and sector coverage responsibilities. Finally, Morningstar looks at the manager's other responsibilities (such as helping to market the fund) that may detract from the time he is able to spend with his portfolio.

3. Investment Process and Style

Clearly articulated and consistently applied investment processes are typically the hallmark of outstanding funds. Morningstar looks at a fund’s investment process, including stock screening, portfolio construction, sector allocation and risk management. Morningstar has no particular bias towards any investment style or process. However, Morningstar will assess the skills set of the managers to see if the investment style is a good fit and whether or not the manager has stayed true to his stated style. Once Morningstar understands a manager’s process and style, they will look at how the manager goes about constructing his portfolio from a research and risk control standpoint.

Evaluation Criteria for Prospective Products for Inclusion under the CPFIS

The information provided below is intended to let FMC gain a better understanding of the criteria applied in the evaluation process so that the FMC can assess whether a product has a reasonable chance of receiving a favorable evaluation before they submit an application for evaluation. Morningstar uses a two-tiered review process. The first step is the implementation of quantitative analysis. The second step is a qualitative research process.

Quantitative Analysis

Morningstar’s quantitative analysis serves to measure a fund’s overall quality. Four factors are taken into account in this step: returns, risk, manager tenure and expenses. Each individual fund’s return, risk, and expense history are compared with its category peer group. Performance consistency - This screen identifies funds whose trailing returns obscure periods of significant underperformance. Quartile performances over rolling 12-months, 3- and 5-years (where available) along with the discrete calendar year periods in the last 5 years are looked at. Frequent periods of underperformance often reflect something inherent in the fund’s style that leads to unpredictable performance. Style consistency (equity funds and allocation funds only) - A reasonable level of style purity is expected so that investors can rely on a fund to fill its expected diversification role. Management Tenure - Funds with minimum manager change are generally preferred. New management requires close scrutiny to ensure not only performance continuity, but also that a fund’s general investment process and style remain the same. Expenses - Expenses are the most persistent and predictive component of a fund’s returns. Funds with expenses that are markedly higher than their category’s average are not preferred. Proprietary Risk and Performance Ranking

Qualitative Analysis

The second tier or leg is the qualitative research process. Some of the factors which are considered in the qualitative assessment include: a) Manager’s History of Success – Morningstar reviews the manager’s performance and risk record against his or her peers in the same category - not just at the manager’s current fund but also at any other funds they’ve managed in the past, as well as at any other funds they’re managing currently. b) Organisational Strength: Same as above c) Investment Process Consistency: Portfolio composition and concentration Morningstar analyses the subtleties of the managers’ investment process to understand what drives their performance. Successful funds tend to be driven by consistent strategies as opposed to strategies that accommodate market conditions. Morningstar assesses whether a manager’s investment process leads to a more aggressive or more conservative performance profile relative to its peers, and how a manager’s process might lead to persistent over or under weights in certain sectors. For periods of underperformance or out performance, Morningstar assesses how much can be explained by style traits and how much can be credited to manager’s skill. d) Asset Size & Asset Growth - Morningstar looks at how performance has changed as a manager’s assets have grown.

Ongoing Due Diligence

Morningstar spends considerable resources providing ongoing monitoring and evaluation of the funds and the managers. Manager’s quality will be continually evaluated. When a manager’s quantitative or qualitative evaluation indicates significant changes, Morningstar may consider recommending a re-evaluation. This ongoing commitment helps ensure the highest quality recommendations. Morningstar has established watch list criteria that are monitored at pre-specified intervals. Examples of watch list items are: Deterioration in performance Style drifts Securities held outside of mandate Change in investment philosophy or process Manager turnover Compliance or regulatory issues

Required Documentation & Notifications from FMC:

FMCs are required to submit to Morningstar the following: Document: Submit to: Full portfolio holdings preferably monthly; quarterly at a minimum portfolio@morningstareurope.com Timely notification of any event that may impact fund performance or organizational structure: including but not limited to: manager change, portfolio strategy change, corporate actions, regulatory issues, etc. cpfis@morningstar.com Prospectus (annual & semiannual reports) cpfis@morningstar.com Monthly Fact Sheets cpfis@morningstar.com

For enquiries please contact: cpfis@morningstar.com

Update Ref: IVD-PMF-CY Morningstar Evaluation/Apr 2008 IVD-PMF-CY Revised Mercer Evaluation/Jun 2007 IVD-PMF-ML/FMC&ProductsDueDiligence/May 2003

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