Risk tools are to hand

With the increasing globalisation of investment, the growing complexity in instruments and the rise of alternative investment strategies, there is a greater need than ever for investors to be able to measure, monitor and control their risks. In addition to traditional measures such as tracking error and benchmarks, over the past decade a number of methodologies have appeared, such as value-at-risk and Monte Carlo simulations, that give further insights into exposures across portfolios.
The sell side took the lead in developing these new approaches and the technology required to implement them. Now, however, the technology is migrating to the buy side, and incorporating new and old methodologies. Traditional buy side software suppliers are adding risk management modules to their systems, while some sell side software suppliers are revamping their software for pension funds and asset managers. And some new companies have emerged that are offering risk applications for rent online, thus making it more affordable for smaller firms.
New York-based RiskMetrics is a spin-off of Wall Street giant JP Morgan Chase. Its software was originally developed to give the bank a daily snapshot of its overall exposures in the form of a probability of a maximum loss for a given time horizon – the value-at-risk. Since then, RiskMetrics has adopted its software for asset managers and recently released PensionMetrics, which extends the traditional short-term horizon of VAR to a strategic time horizon of three months to one year.
Pension funds and asset managers are interested in extending their current approaches, says Michael Thompson, market strategist at RiskMetrics. “People already generally practice some kind of risk management but are moving to also use a value-at-risk-based methodology in order to compare results. There is a trend away from the notion that there is one methodology for risk. Instead, there are multiple methods, that are reaffirming when they say the same thing, and when they are different they provide a step towards investigating where problems in a portfolio might lie,” he says.
One of the reasons that risk management technology originated in the sell side and remained confined there for so long was cost. “Risk analysis requires the processing of large amounts of data, maintaining of large correlation matrices, running Monte Carlo simulations and so on, all of which demanded heavy computing resources,” says Thompson. “Now the infrastructure to deliver this is a lot cheaper.”
Microprocessor performance doubles every 12–18 months, although prices remain the same, while a whole raft of technologies and tools have emerged to make it quicker and easier to develop software and to integrate systems. In addition, advances in networks have opened up the possibility of delivering software online in a process known as application service provision (ASP). This can reduce both upfront costs and the need for in-house technology expertise.
New York-based Askari is another supplier that started out developing risk applications for the sell side, but turned its attention to the buy side when it was acquired by State Street in the late 1990s. Last year, Askari introduced an ASP version of its software called TruView, which allows clients to benefit from total outsourcing of data and system management, while retaining the ability to customise the application’s analyses to their particular requirements, says Askari president Peter Davies. First to sign up for the service was Boston-based Partners HealthCare System.
Other custodian banks as well as prime brokers have introduced risk analysis as part of their services to investment firms. These include Deutsche Bank, CSFB and Morgan Stanley. The two latter firms use analytics engines supplied by Toronto-based risk management technology specialist Algorithmics. In a recent deal, market information provider Bloomberg is incorporating the company’s analytics into its services for traders and investors. Algorithmics also supplies its systems directly to firms to install in-house and buy side clients include Old Mutual Asset Managers and Rothschild Asset Management.
California-based Barra’s equity and fixed income risk factor models have been widely used in the investment community for many years. More recently, the company has turned its attention to enterprise risk management and supplies the TotalRisk package.
“A comprehensive view of aggregate risks enables an asset management firm to avoid taking unintended bets, ensures optimal diversification at all times, and allocates resources appropriately through accurate assessment of risk/reward trade-offs,” says Aamir Sheikh, president of Barra. Technology should enable a consistency between the analysis on a comparatively small set of assets viewed by a single portfolio manager and the aggregated analysis of the entire enterprise viewed by senior management. A risk management system should offer a robust methodology that provides accurate and unbiased risk forecasts across multiple asset classes, he says.
Barra has supplied TotalRisk to some of the world’s biggest pension funds and asset managers, including California Public Employees’ Retirement System (Calpers), the Netherlands’ ABP Investments and Merrill Lynch Investment Managers (MLIM). Calpers and ABP cited cross-asset support, state-of-the-art analytics and integrated market and credit risk management as decisive factors in their choice of the system. MLIM said that had been looking for a risk management system to give it a consistent view across locations and products, and to enable it achieve a strategic investment management focus with tracking error, benchmarks and risk measures.
The suppliers of general investment management software have also been turning their attention to risk management recently. Some have been developing their own modules while others have entered into partnerships with the risk specialists. For example, financial systems supplier Computer Sharing Finance has teamed up with fellow Milan-based company RiskMap to integrate the latter’s risk analytics engine into its portfolio management products.
New York-based SunGard Trading and Risk Systems has linked two of its products – the Decalog trading and portfolio management system and the Panorama risk management system - and made a number of joint sales, for example to Paris-based Dexia Asset Management, Rome-based Romagest, the asset management arm of Banca di Roma, and Systeia Capital Management, a new Paris-based hedge fund.
“Asset management firms are increasingly recognising the need for active risk management as they trade in more volatile markets, using complex products such as structured derivatives,” says Gavin Lavelle, president of the Panorama operating unit of SunGard. “They concurrently face increased pressure from institutional investors for robust risk versus return measurement and management practices.”
An issue that has emerged with the growth of the hedge fund sector is how investment firms can discover and manage the risks of their allocations to these firms. As Neil Paragiri, head of hedge fund markets at New York-based risk management ASP Measurisk, points out, institutions tend to allocate funds to a number of hedge funds or to a fund of funds and it can be a bigger task than the institution wants to take on to gather information from these multiple sources and calculate overall risk exposures. Furthermore, hedge funds are often unwilling reveal detailed portfolio information. Measurisk is one of a small number of companies, which also includes GlobeOp Financial Services and, that provides an independent service to do this. Measurisk clients include the World Bank (to manage the risks in its hedge fund investments), Fairfield Greenwich and Blackstone Alternative Asset Management, both based in New York.
Meanwhile, risk management software is emerging for hedge fund themselves. Xenomorph Software and Reech Capital, both based in London, have recently launched products tailored to hedge funds. Xenomorph’s PerfectVine features integrated trading and risk analysis with data warehousing, position keeping and risk reporting. Earlier this year, Reech launched RiskHedge, an ASP that will handle all asset classes and trade structures and offers reporting flexibility and customisation, says Christophe Reech, chief executive of Reech Capital.
“There is increasing pressure for transparency coming from investors, counterparties and regulators,” says Reech. “This places a demand on hedge funds to demonstrate risk management techniques and risk-based returns via flexible reporting.”
With the growing range of software aimed at the investment community, firms now have a fair amount of choice, and little excuse not to obtain the tools to help them better manage their risks.

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