Explanation:
The correct answer is C.
Discussing the findings with the portfolio manager and senior management is the most appropriate action. The Risk Management Unit's (RMU) role is to monitor, measure, and report risks, not to make direct investment decisions or unilaterally force portfolio changes. A lower-than-target tracking error implies the fund is taking less active risk than mandated, which might result in underperformance relative to expectations for active return. The RMU should communicate this finding so that senior management and the portfolio manager can decide whether the conservative stance is justified under current market conditions or if the portfolio needs realignment to meet its original investment mandate.
A is incorrect. The RMU typically acts in an oversight and advisory capacity; it does not directly instruct portfolio managers on specific asset allocation or security selection decisions.
B is incorrect. The RMU has already identified the underlying reason for the lower tracking error (the portfolio manager's conservative investment approach), meaning the proprietary risk forecasting model is likely functioning correctly and accurately reflecting the portfolio's actual risk profile.
D is incorrect. While a lower tracking error does indicate less active risk, it also means less potential for active return. Investors in an actively managed fund pay higher fees with the expectation that the manager will take a specified level of active risk to outperform the benchmark. Failing to meet the target tracking error represents a deviation from the fund's mandate.
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Q.2537 Phoenix Capital, a prominent asset management firm, has a successful Emerging Markets Equity Fund. Their Risk Management Unit (RMU) uses a proprietary model to estimate a forecasted tracking error. Recently, the RMU noticed that the forecasted tracking error for the fund was consistently lower than the target established by the firm's investment mandate. The RMU identified that this is due to the fund's portfolio manager having a more conservative approach and holding a larger proportion of assets in stable, less volatile securities. Which of the following actions is most appropriate for Phoenix Capital's RMU in response to this finding?
A
Immediately instruct the fund's portfolio manager to invest in more volatile securities to increase the tracking error to the target level.
B
Initiate a review of the proprietary risk forecasting model to ensure it is functioning correctly.
C
Discuss the findings with the fund's portfolio manager and senior management to understand the reasons and evaluate the need for any portfolio adjustments.
D
No action is required as a lower tracking error means less risk, which is beneficial for the investors.