All investments involve at least some risk. What is important is that a UCITS fund adheres to the level of risk it has told investors it will take. Managers must have procedures to measure the risk of a fund’s investments at all times, and the risk management function must be independent of the portfolio management activity, to minimise the possibility of conflicts of interest. The manager may hire an outside firm to provide risk monitoring and measurement if necessary.
The risk management procedure for a UCITS fund must be appropriate, fulfil specific requirements, be described in detail, and approved by the CSSF. One of the best-known approaches to measure the risk of loss of the fund’s investments is value at risk or VaR, but others may be used as long as the regulator agrees that this is appropriate for the fund’s risk profile. The use of an advanced risk methodology is required where the fund is following a complex investment strategy or where it invests significantly in derivatives.
The investment compliance function, which in some companies is a part of the risk management function, must monitor compliance with the fund’s policy and procedures and with the UCITS investment and diversification rules; it reports to the fund’s board of directors on its activities, including details of any remedial action taken to correct deficiencies. It will also alert the fund manager’s executives to actual or potential breaches of limits, and should oversee valuation procedures for OTC derivatives.