Going beyond performance
Difficult markets and lower returns have caused pension funds to look ever more closely at performance, either of internal or external portfolio managers. At the same time, they want to examine their risks in more detail, and in conjunction with performance. This has led to a demand for systems and services that integrate performance and risk, with software suppliers often acquiring complementary products in order to offer an integrated system. Meanwhile, the demand by pension funds for outsourced performance measurement has not declined – instead funds are now asking for more consultancy services around the raw numbers.
Sparinstitutens Pensionskassa, försäkringsförening (SPK), the pension fund of Sweden’s Swedbank, is currently upgrading its performance measurement capabilities. Previously, the fund operated a system that provided a monthly performance report of its asset managers and the asset classes in which it chooses to invest. Now SPK is implementing an integrated performance measurement, risk measurement and back office system from Copenhagen-based SimCorp that will receive data on every trade undertaken by its nine managers, rather than just aggregated asset values. SPK has always looked at risk in conjunction with performance, and will continue to do so with the new system, says Peter Hansson, currently chief financial officer of SPK who is due to take over as chief executive in January 2005.
Receiving investment data from asset managers and running a performance measurement system in-house allows SPK to aggregate the data on its investments and to compare asset managers on a like-for-like basis. This information also enables SPK to go out to managers and present them with its own analysis before asking for the managers to interpret their own performance. “So we are driving the discussion rather than just listening to what they are reporting,” says Hansson.
London-based asset manager F&C says that the current main concerns of its pension fund clients in terms of performance reporting are the requirement for fixed income attribution and analytics, compliance with the global investment performance standards (GIPS), reporting of geometric relative returns (rather than absolute arithmetic difference to the benchmark), and risk reporting in terms of ex ante and ex post tracking errors.
“Nowadays, you have to look at risk at the same time as performance measurement,” says Mark Godfrey, head of performance at F&C. “Some mandates from clients now specify ex-ante or ex-post risk limits. And when we are looking at risk, we try to keep things as simple as possible. When going to pension fund trustees, they don’t want pages of numbers, so we stick to things like tracking error, information ratio, Sharpe ratio and so on – things that can be explained in English.”
F&C operates a number of systems for its reporting – for performance it has systems from StatPro and DST International, both based in London; and for risk, it has systems from Barra and Wilshire, both based in California, and from Boston-based Northfield Information Systems. With these systems, F&C is able to, in addition to its conventional hard-copy reports, publish performance and risk information on its extranet for clients to access directly – a practice that is increasingly in demand by pension funds.
The separate sourcing of systems for performance and risk has been the norm among asset managers and pension funds that manage their own assets until the recent growth in interest in risk, which has led to a demand for integrated performance and risk functions. Traditionally, software suppliers have specialised in one area or the other, but over the past couple of years a number of suppliers have acquired products to complement their main applications.
Risk management system supplier Barra has acquired London-based performance measurement and attribution specialist Investment Performance Objects (IPO), investment management and performance systems supplier DST has acquired New York-based buy-side risk management systems specialist Askari, and performance measurement system specialist StatPro has acquired Milan-based risk management systems specialist RiskMap.
In addition, investment and portfolio management systems suppliers, such as SimCorp, are increasingly offering risk measurement and attribution as well as performance measurement in their systems. Mikkel Mørdrup, a vice president of SimCorp in Stockholm, says that in the past three years his company has seen a developing trend among asset managers and pension funds away from buying best of breed systems for each function, such as portfolio management, performance and risk, to a single integrated system that can perform all functions.
This has been driven not only by a need to better understand the nature of investment returns, but also by cost concerns. “There has been a lot of focus on reducing costs at pension funds, and so there is a move to decrease the number of systems and the interfaces and reconciliation they require,” says Mørdrup. One of the advantages of an integrated system is that the investment management module will already have the data required by the performance and risk modules.
Gavin Little-Gill, senior analyst in the investment practice at Boston-based financial services research and consultancy organisation TowerGroup, says another factor driving the demand for more sophisticated and integrated performance and risk measurement is the fact that, in their search for better returns in difficult markets and for more predictable performance, pension funds and their asset managers are turning to more complex products, including derivatives and hedge funds, resulting in more complex portfolios. “Institutional clients are aggressively evaluating their asset_managers’ performance and demanding more detailed and more frequent analysis performed over longer and more flexible time horizons,” he says.
The proprietary systems, frequently based on the Excel spreadsheet, that asset managers until now have often used for performance measurement, are straining under the additional requirements, leading firms to evaluate third-party systems, or to undertake significant upgrades in processing power to support their current systems, says Little-Gill.
But while asset managers and pension funds that manage their own assets are upgrading their performance and risk measurement systems to meet today’s demands, many pension funds and their trustees are still outsourcing performance reporting to organisations such as Washington State-based Russell Mellon and Edinburgh-based WM Company.
“Trustees still place a value on independent performance measurement,” says Eric Lambert, head of performance consultancy at WM Company. “While their asset manager will all have performance measurement available to them, trustees like an independent view of that. Also, given that investment structures are nowadays very often multi-manager, trustees like that consolidated.”
But it is not just a reporting of the performance figures that trustees are after today, says Lambert. In response to the Myners report, which challenges trustees to do a number of new things, such as evaluate their own decision making and the advice they receive from their investment consultants, WM now finds there is a demand for what Lambert calls fund evaluation, rather than simple performance reporting. “We are increasingly going beyond the return on the assets to reporting on fund management structure, the costs and risk associated with achieving the returns and so on. It is a much broader remit these days than 10 years ago.”
And as with internal systems for performance measurement, there is now a demand on outsourced services providers to offer risk measurement along with performance. “Increasingly we have to report on risk – risk is very much part of our standard service these days,” says Lambert.
WM Company is now part of global custodian State Street. Global custodians are currently making a big push to provide services such as performance and risk measurement to their custody clients. The custodians have one advantage over the traditional performance services providers in that they already have the client’s investment data in full detail. But Lambert notes that what most global custodians want to offer is simple performance measurement, and not the fund evaluation that he now thinks is essential. “The_custodians are good at analytics, in the main they don’t have the people skills in going to clients and explaining the_analytics to them,” he says.