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Preparedness Called Key to Managing Risk

SAN DIEGO, Calif. - Effective risk management of mutual funds extends beyond instituting portfolio controls to complying with regulations and, most importantly, maintaining reputation, mutual fund executives told their peers at the Investment Company Institute's tax and accounting conference here last week.

The best method of protecting a mutual fund company against risk is to prepare for as many problems that could occur as possible and to take out insurance, mutual fund executives said.

Firms must designate personnel to handle situations and document how various situations should be responded to, said Mark Osterheld, director of fund operations oversight for Fidelity Investments of Boston.

Unforeseen problems occur on a regular basis but can be tackled with thorough defense plans, Osterheld said.

"The best defense is the best offense," said Kenneth Gorvetzian, vice president and senior counsel of the fund business management group of Capital Research and Management Company of San Francisco.

"On June 30, the Fed raised overnight rates, which caused bonds to rally," said Osterheld, citing an example of a time when preparedness was crucial. "But on the very same day, a major bonds pricing vendor was unable to meet its bonds pricing end-of-day 3 p.m. deadline," he said. But Fidelity was able to cope with the situation because it had previously assigned personnel to handle just such a problem, Osterheld said.

As simple as it may sound, it is critical to "train people to cover practical and theoretical situations, and cross train staff so that they can fill in," he said. Fidelity has found it very helpful to document its risk-management procedures on the Internet because that makes them easily accessible and in a format that can be updated, Osterheld said.

The only practical approach to building a risk defense plan is to cooperate with portfolio, marketing and advertising personnel, Gorvetzian said.

"I want our business people to think that our compliance officers are their friends," he said. "You also need buy-in from the top."

One new development that concerns Gorvetzian is simplified prospectuses. "Boiled-down language" may exclude too much information and appears to make one fund look too much like another, he said. Firms should also be on the lookout for personal investing by portfolio managers and should use software programs that can track parallels between their buys and movements of a fund because regulators may ask for that data, Gorvetzian said.

"Meet with your traders, your salespeople and advertising and marketing executives," he said. "Ask them what they are doing and explain to them the why's and the how's of liabilities and regulations."

Despite a company's best efforts though, because no risk-management program can foresee all of the problems that might occur, "even a risk-management system is subject to risk," said Frank Vento, vice president of underwriting for ICI Mutual Insurance Company of Washington, D.C. This is why mutual fund firms must take out insurance to cover risks, including those it is virtually impossible for a company to anticipate, said Vento. And unlike shopping for auto insurance, the least expensive insurance policy may not be the right one for a mutual fund company. In fact, it is not wise to look for exclusions in policies to reduce rates, particularly exclusions that would eliminate coverage for liabilities for actions undertaken prior to the date the insurance is taken out, Vento said.

"Cover informal SEC investigations as well as both the fund and your investment advisors," Vento said. "Don't bargain over exclusions."

Mutual fund companies should also work closely with insurance companies to make sure that they are keeping up-to-date with developments in the mutual fund world, Vento said.