As institutions streamline their operations in a bid to reduce costs, one area where pension funds have been unable to cut back is in performance measurement. Francis Braeckevelt explains how performance measurement services have evolved.
It is difficult today for any asset manager or owner to get by without some form of performance measurement. In these tight economic time,s they all face similar key issues — asset integrity, portfolio volatility, attribution and compliance — which require advanced management tools and services.
The market disruptions of 2007-2009 illustrated that many institutions are not well equipped to handle risk measurement in-house. As a result, institutions have increasingly turned to third-party participants with the required insight and the ability to highlight the finer detail about their portfolios.
There are three key themes which stand out in terms of what financial institutions are asking measurement and analytical companies to provide:
More - Clients are requesting more services, from counterparty monitoring to scrutiny of investment management guidelines.
Faster - Starting around the time of the Lehman’s collapse, institutions increasingly began requesting performance earlier and on a daily basis.
Better - Improved capabilities for derivatives and other sophisticated investment instruments.
Financial institutions are asking for more granular and timely information, and have become increasingly focussed on risk management and risk budgeting. A few years ago, the focus had been on the return side of the business and with little understanding of risk. In down markets, there is more emphasis on understanding and managing risk and its relation to the underlying performance characteristics.
Investors have reverted to the ‘back to basics’ risk-return framework and are looking to dissect and better understand the highly interrelated risk and return sources and drivers of their portfolios. The actual models and methodologies are being scrutinised and re-assessed further. Regulators have introduced additional rules, in a previously highly un-regulated environment, to protect the investors through enhanced transparency and corporate governance policies.
Performance measurement and risk analysis have clearly proved their strategic importance in an increasingly complex environment that requires a comprehensive and integrated approach tailored to meet an investor’s specific requirements. These may differ significantly based on investor or fund return requirements, investment horizon or the complexity of the strategy.
It would therefore not come as a surprise that the most critical requirements of an effective performance and risk management model are data and people. Access to timely, accurate and consistent data to measure risk and performance is the basis of any effective model whether it is market, portfolio, security or advanced accounting information. Investors also need to rely on efficient tool sets to review and cleanse data to safeguard the integrity of the information provided.
On the people side, where previously, practitioners may have been given a false sense of security receiving a multitude of data from highly sophisticated models, they may not have necessarily understood the numbers or calculations as well as they should have. After the recent downturn, however, users recognised that the analyst expertise and experience are equally if not more important to evaluate, analyze, interpret and translate the results into meaningful messages and actionable strategy re-alignments.
Given the ongoing evolution of the market’s requirements, specialist providers stepped in to assist investors in coping with the time and resource constraints of collecting and calculating robust performance and risk data. They have helped clients improve their decision-making process through analytical insights in the risk-return characteristics of their investments. They also developed flexible systems, able to respond to changing market conditions or additional regulatory or client requests.
The custodian’s role as a central data repository in the post execution trade life cycle, has positioned it well, to roll out modular services that are evolving from the traditional static models towards highly data-centric standards.
These models allow for innovation and customisation to meet regulatory, market or client specific requirements. Enhanced reporting procedures allow investors access to sophisticated, real time tools with flexible report-writer options and capabilities.
The bottom line is that performance measurement forms the basis for sound decision-making. You need to know where you are and precisely what your performance has been. Performance measurement and risk management have become an integral part of the investment process. Regulators and industry associations like the CFA Institute are increasingly looking to institutionalise global best practice standards in this area.
Ongoing investment in a robust performance measurement process, plus the talented folks that manage it, may help to identify some early warning signs and allow investors to take some action.
Francis Braeckevelt is Head of Planning & Development - Asia Pacific at BNY Mellon Asset Servicing