Tools to obtain overall view
With returns harder to achieve, pension funds and their asset mangers must look more widely for where to make their investments. This inevitably means new, if not greater, risks to contend with, and, consequently, a requirement for tools to analyse, monitor and manage those risks. Developers of risk management software, many of which started out by creating applications for the sell side, are now adapting or creating new tools for pension funds and their asset managers.
“Pension funds are now investing in more complicated portfolio structures, not only in terms of the individual instruments but also in terms of how those portfolios are put together, with the objective of achieving better risk-return characteristics,” says Mark Dwyer, vice president, risk division, at London-based investment management software supplier DST International.
Complicating the picture even further is the fact that where asset managers provide the pension fund with risk information it is likely to be in a range of formats, using different methodologies, different data and distributed at different times, says Dwyer. “So although the pension fund might be able to get reasonable information from each individual manager, it is difficult to get an aggregate view of risk is because of the different methodologies, etc.”
To deal with this problem the pension fund could try to get consistency of reporting from the asset managers – something that is hard to achieve, says Dwyer – or adopt a risk methodology internally. The pension fund could develop an application itself, or look to the small but growing number of tools that are being developed or adapted specifically for the pension fund market by software suppliers like DST International, London-based StatPro Group and Copenhagen-based SimCorp.
Toronto-based Ontario Teachers’ Pension Plan (Teachers’) is in the process of installing DST’s HiRisk risk management system to calculate plan level and portfolio level market risk for all asset classes. The ability of the system to handle complex portfolio structures and benchmarks was a key factor in the organisation’s choice of application, says Leo de Bever, senior vice president, research and economics, at Teachers’.
One of the major obstacles to pension funds doing their own risk management has been the skills and resources required to install and operate a software application. However, the evolution over the past few years of the application services provision (ASP) approach to delivering software, whereby an organisation uses the application online rather than installing it in-house and pays a rental fee rather than a usually large upfront installation fee, now makes it considerably easier and cheaper to obtain the use of sophisticated modern risk tools. DST International offers its HiRisk software both as an ASP and as an in-house installed system.
StatPro offers a suite of ASP-based applications, including risk analysis, performance measurement and attribution, a shared database and reporting. Called StatPro Risk Management, the suite is aimed at asset managers as well as pension funds. Meanwhile in September, the company launched StatPro Portfolio Insurance with a particular focus on the pension fund market. The application allows users to define a set of future cash flows that a portfolio must achieve to meet future liabilities and the system will calculate a dynamic strategy that will ensure that the net asset value of the portfolio will not breach present value of the liabilities, says Dario Cintioli, chief executive officer of StatPro Italia, the Italian division of StatPro.
In the current environment with the search for adequate returns, it is important for pension funds to have effective systems in place to supervise asset managers’ true performance and to ensure that funds are managed according to the compliance rules in mandates, says Kjell Nordgard, managing director of SimCorp. But these systems must not be such that they lock the pension fund into certain asset managers. “Pension_funds need to have flexible computer systems and infrastructures so that they are able to switch fund managers and to change mandates and strategies,” says Nordgard.
Meanwhile, the asset managers themselves also need this flexibility. “Asset_managers need to have systems and procedures in place that will support changes and new strategies so that they can swiftly take advantage of, or reduce the negative impact of, market fluctuations,” says Nordgard. Furthermore, to improve their overall performance asset managers also need to reduce their operational risks in order to keep costs down. There are a number of technology strategies than can assist with this, says Nordgard, including the automation of transaction processing to reduce manual errors, the use of messaging standards such as FIX and ISO15022 for communicating information with clients and counterparties to improve efficiency and reduce misunderstandings, the consolidation of systems (replacing several standalone systems for order management, performance measurement and attribution, reporting, etc, with a single, integrated system) which will reduce the need for data transfer and reconciliation between databases, and the use of electronic matching and settlement. The Dimension investment management system supplied by SimCorp, whose customers include Alecta and Skandia Link pension funds in Sweden and Allianz Dresdner and Munich Ergo asset managers in Germany, offers an integrated system with straight-through transaction processing. In addition, the company recently introduced a portfolio modelling and re-balancing module that automates the adjustment of portfolios to comply with pension fund mandates.
Other suppliers that have recently extended existing applications or introduced new modules for risk management on the buy side include London-based APT, California-based Barra, Boston-based New Frontier Advisors and New York-based RiskMetrics Group.
APT recently added a performance analysis and attribution module to its risk reporting software that ensures consistency between performance and risk analysis. The application uses APT’s single integrated model for equities, bonds and derivatives. Last month Barra released a web-based set of analytical tools for screening, selecting and monitoring credit-risky assets. Called Barra Credit, the application brings together comprehensive data on equities, corporate bonds and credit derivatives with Barra’s market-implied credit measures enabling users to identify deteriorating credit problems and relative value opportunities, screen and monitor a large universe of assets, and integrate quantitative and fundamental analysis techniques.
Last year, RiskMetrics made all of its risk applications and services available via an ASP platform called RiskMetrics Direct, including its RiskManager real-time market risk analytics application, CreditManager application for credit risk which features a new Credit Pricer module which calculates in real time the marginal capital impact of a prospective new transaction or line of credit, and CDOManager which prices synthetic collateralised debt obligations (CDOs) – increasingly popular instruments for those organisations seeking better performance from their fixed income portfolios – based on the spreads on the underlying names, as well as pricing sensitivities to correlation and individual name spreads.
With suppliers such as APT, Barra, RiskMetrics, SimCorp and StatPro offering both installed and ASP versions of their risk management software, organisations need to decide which is most appropriate for them. “You wouldn’t want to build a technology infrastructure just to do risk management,” says Dwyer. “But the technology overhead of adding risk_management is relatively small if you have got a technology infrastructure already. Besides, if you have the infrastructure it makes sense to install the risk management application in-house because the data you collect during the risk management process – quality historical information about the underlying securities and variables in the portfolio – is very valuable and can be used in other processes in the business.”
While pension funds consider whether to adopt their own risk management tools, asset managers are under increasing pressure to acquire sophisticated risk analysis capabilities. “Pension funds are demanding of their managers that they demonstrate that they understand the complexity of the_investments they are taking on, while also having the risk management techniques to handle the risks,” says Dwyer.
“That doesn’t mean you want the manager to reduce the risk – you may want them to increase the risk – but it does mean that you want him to have clarity about the risk perspective,” he says.