The views
expressed in this column are solely those of the author and do not reflect the
views of SVB Financial Group, or Silicon Valley Bank, or any of its
affiliates.
A B C
Easy as 1 2 3
Or simple as do re mi
A B C, 1 2 3
Baby you and me
- The Jackson 5
The foundation of any building is meant to last a long time. The very nature of these most important building blocks is that when they go, the building will go. This importance carries over into the financial world as well.
Unfortunately, the builders of the financial world were not so proactive in choosing their foundations. It even seems sometimes that the foundation of many security vehicles come about by happenstance as opposed to deliberate choice.
In fact, one of the many fallacies being exposed today about the financial world is the activity, duty and purpose of the ratings agencies. Contrary to what many believe, ratings are not handed down from a power on high, implying that a triple-A investment can never go wrong (just ask former and current auction rate holders about this one). Instead, a triple-A rating simply means the opinion of the rating agency is that the credit worthiness of that particular borrower is very high. It means nothing more and nothing less.
Many of us in the investment industry actually do understand the difference very well and because we know we cannot rely solely on these third-party analytics, we spend a great deal of resources performing proprietary credit research to come up with our own rankings and comparisons.
What's interesting is that we continually find AAA-rated bond issues that we would not touch with a 10-foot pole, but find many A-rated issues that are perfectly acceptable within our total investment set.
The government is starting to figure this out, too, as evidenced by last week's announcement that the SEC is proposing to delete all references to credit ratings from certain investment company act rules. For example, the SEC is proposing to amend the definition of an eligible security for money funds as one that "presents minimal credit risks (which determination must be based on factors pertaining to credit quality and the issuer's ability to meet its short-term financial obligations)."
This is very different from saying you must limit yourself to A-1/P-1 or better securities. It also very clearly puts the onus for performing such credit research directly on the shoulders of the fund's board of directors. Is this fair? Well, I'm not sure where that onus rested before.
If board members could simply point to the ratings agencies and say "they had faulty credit research so I am not liable," then I'm not sure why we need the fund managers in the first place. Clearly, the foundation of this near $3 trillion industry needed more than a little spackle.
But it's not just the money fund industry. In all my years of reviewing client investment policies, never have I seen one that states anything similar to what the SEC is proposing. To my knowledge, there is no board of directors of any technology, life science or other industry firm who charges its CFO with determining credit risk of the company's investments. Instead, investment policies rely on credit ratings. So what is the solution?
Well, I actually believe the credit ratings to provide some value to our world. They create a starting point for the analysis of which issuers should be allowed in our portfolios and which should not.
The buck has to stop somewhere and in the case of an outsourced investment manager, it must stop with your portfolio manager — the guy making the investment decisions on the ground. If your asset manager is relying on the ratings agencies and cannot answer your due diligence questions regarding their investment philosophy, process and credit analysis, then you should change asset managers.
It is your fiduciary duty to do so.
Key Developments
The magnitude 8.9 earthquake in Japan caused oil to drop the most in four months and broke the decline in global equity markets as a temporary closure in refineries weakened demand. The yen rallied as investors bought the domestic currency as a haven while the Nikkei 225 fell to the lowest point since January. The Bank of Japan vowed to ensure financial stability in the wake of the economic impact.
The Bank of England kept its benchmark interest rate at a record low of 0.5 percent for the 25th month as policy makers chose to set aside concerns on rising inflation pressures and continue measures to stimulate the economy. Policy makers also left their bond purchase program at 200 billion pounds ($324 billion) as predicted by all economists surveyed.
Retail sales increased in February by the most in four months. Purchases climbed 1 percent after a revised 0.7 percent increase in January that was more than double the previous estimate. Automobiles, clothing, and electronics led the purchases.
Consumer borrowing increased for the fourth month in January to $5.01 billion. The gains were led by loans for automobiles and education. Revolving debt decreased $4.25 billion in January and non-revolving debt rose $9.26 billion for the month. The report does not track debt secured by real estate, such as home equity lines of credit.
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