Bringing it all together
Risk management technology suppliers have been upgrading their tools for measuring, monitoring and controlling risk, with many new features promised for 2003. Although risk technology largely originated on the sell side, over the past few years more suppliers have been adapting their systems for investors, or starting afresh to create new buy-side oriented tools. However, while investment risk is now reasonably well covered, pension funds are still some way from having available to them a choice of tools that cover all their major risks and can integrate the information into usable reports.
Last year, California-based buy-side risk management systems specialist Barra introduced a new portfolio management and risk analysis service called BarraOne. Features of the system include the ability to customise analysis, including the ability to integrate analysis of different asset classes. Users can determine the risk in portfolios in absolute terms or relative to a benchmark with as much detail as is required, and investigate the impact of adjustments in their portfolio. But the distinguishing characteristic of BarraOne is that is available as an application services provision (ASP), where instead of users installing the software on their site, with all the costs and expertise that requires, they can rent it online.
BarraOne is an alternative to the company’s TotalRisk risk management system, which must be installed on-site, and which is used by some of the world’s biggest pension funds, such as California Public Employees’ Retirement System (Calpers) and the Netherlands’ ABP Investments. These firms have the resources to purchase the system and operate it in-house. BarraOne eliminates the need to have the software on-site, but still gives the user control of the data input and analysis.
Meanwhile, in the UK Barra offers a third way for pension funds to access its software via a joint venture with London-based investment information services firm Russell/Mellon CAPS. Called Risk Reporting, the venture offers pension funds a bureau service for investment risk measurement and reporting. Pension funds send their portfolio holdings data to Risk Reporting, which runs it through Barra’s TotalRisk system for the calculation of tracking error and risk attribution and sends back reports, by manager if there are multiple managers and portfolios, as well aggregated across all portfolios.
The service currently analyses around 200 portfolios, for single and multiple portfolio pension funds in the UK. “Risk Reporting is applicable to any pension fund managing risky assets,” says Andrew Cauldwell, senior vice president for Europe and Asia-Pacific for Barra. It offers less control over the analysis process than BarraOne or TotalRisk, although it can be considerably cheaper depending on the number of portfolios the pension fund runs.
Last year, several Risk Reporting executives left the company to set up an alternative service with the aim of combining risk and return analysis. Called Portfolio Evaluation and based in Harrogate, the service uses risk, performance and attribution software from California-based Wilshire Associates.
“Our philosophy is that you shouldn’t look at risk unless you look at the return associated with it and vice versa,” says Nick Kent, a director at Portfolio Evaluation. “What we help our clients do is measure the risk and return of each portfolio and determine if they have had sufficient return for the risk they have adopted.” The service also attributes the risk and return, to managers, styles and so on.
The service gathers data from the clients at the stock or bond level (the service covers equities and fixed income), as well as interim information on transactions, and recalculates on a daily basis their portfolios and risk components, using pricing and risk information supplied by Wilshire. It then runs attribution analysis, also on a daily basis. Where a pension fund has more than one manager, the service will aggregate the information as well as providing attribution information on how much risk and return came from the individual managers. “In this way we can tell the pension funds how well they are doing relative to their strategy and their asset/liability allocations,” says Kent. And because the risk information is available together with the return information, users are getting ‘the whole story’ and can find it easier to understand the meaning and implications of the individual figures. In addition, the service can be tailored to a pension fund’s particular requirements.
Portfolio Evaluation claims it already has a blue-chip client list, although it won’t reveal client names, but says that its service is most likely to appeal to, and be affordable by, the top 250 pension funds. In theory, it could appeal to investment managers as well, although Kent says if they have a large number of portfolios then it is probably cheaper to install the Wilshire software themselves.
Services like Portfolio Evaluation that bring together various related analyses of pension funds’ assets and liabilities are a step in the right direction, says Georg Inderst, director of London-based The Law Debenture Pension Trust Corporation. The problem up till now has been that pension funds and their trustees “don’t have the appropriate tools to give them a top level perspective on their risks,” says Inderst. “Trustees can get bits of information from different parties, but there are not many tools available that will put it all together, especially from a quantitative perspective.”
The investment risk factors that most standard risk management systems tackle is just one of the risks that pension funds face, says Inderst. “And even there the main risk is not being able to pay pensions, rather than not meeting a benchmark.” he says. However, currently available tools tend to focus on tracking error and relative risk rather than the absolute risk that pension funds face.
Furthermore, although there is now a range of tools for measuring investment risk, as well as performance and attribution, there is little available that will bring these results together with risk adjusted performance, asset and liability analysis, and, following the Myners report, trading costs as well. Today, pension funds typically get risk information from a variety of sources. They might get performance data and some analysis from their fund managers or custodians or independent service such as CAPS or Edinburgh-based The WM Company, while consultants provide asset and liability modelling and longer-term analysis. Ideally, this should all be integrated in a single, user-friendly report, says Inderst. “It is important to create tools that help relate short- term developments to medium- and long-term risk and return parameters and funding strategies,” he says. The objective is that pension funds are better able to understand what their most important risks are, and have the tools to explore different potential scenarios that might affect their portfolios and strategies.
Gregg Berman, head of institutional business for New York-based risk management data and software supplier RiskMetrics Group, suggests that pension funds have a spectrum of technology requirements depending on the nature of the organisation. On the one hand, some bigger pension funds operate much like asset managers, allocating investments to managers, and what they require is the ability to analyse tens of thousands of positions by hundreds of benchmarks. This demands a conventional risk management system with strong data management and performance characteristics.
“Then you get the pension plans that want less detail on their positions but more information on general asset classes and the ability to bring in information on liabilities and link it to the assets,” says Berman.
Berman agrees with Inderst that at the moment there are few tools that pension funds can use to look at their assets against their liabilities. RiskMetrics has worked with JP Morgan to create such tools, but says Berman, it is an area where pension funds are looking more for services than for tools they can install and use themselves. “They want a vendor that will run the analytics for them and deliver reports with commentary as to what the figures mean,” he says.
Such services must be built on sophisticated and robust software, not only for reliability, but also for the comfort factor of the pension plans knowing that the analysis has been performed on an advanced and credible system. RiskMetrics is in the process of creating such a service based on its PensionMetrics software which a few larger pension plans have installed in-house.
And there is another type of technology requirement that is a consequence of pension funds moving into the alternative investment market in search of better returns. “Pension plans are used to having transparency with their investments,” says Berman, but because of the proprietary nature of many hedge fund operations this transparency is not immediately available. So RiskMetrics, along with some other suppliers such as Measurisk, GlobeOp Financial Services and PlusFunds.com, are beginning to provide services that gather the confidential position data from the hedge funds, analyse it and provide aggregated reports (that hide the position information) to pension funds. “This gives pension plans the level of comfort in terms of transparency that they traditionally associate with their investments while preserving the confidentiality of the hedge funds strategies,” says Berman.
Meanwhile, other software suppliers that are continuing to develop risk measurement and monitoring tools that are relevant to pension plans and investment managers include Askari, Egar Technology and Sungard Trading and Risk Systems, all based in New York, and COR Risk Solutions, Xenomorph Software and Reech Capital, all based in London.