The edge is in the information

Modern software gives asset managers new views of the state of their portfolios, to the benefit of their clients, writes Fennell Betson

The search for the competitive edge in fund management is taking a new twist. Delivery of asset services is no longer just a question of performance consistent with client expectations, but increasingly covers provision of portfolio information services. With clients increasingly wanting to know what could happen to the value of their portfolios in a range of different circumstances, asset managers are looking to technology to provide the answers.

Princeton Financial, a leading US asset management software supplier, is attacking the European market on this basis. We believe that asset managers have a competitive edge with our PAM system," says Michael Baranack, managing director of Princeton's UK office. "That is one of our marketing strategies." Princeton, with 25 years' experience in the US, opened a UK office in 1995 to service its growing band of European clients. The biggest interest has been from asset managers. "They are looking for a flexible and easily accessible system that lets them pull off the modelling, analytical and reporting aspects they require."

Modern systems have to be able to account for a wide range of security types and handle off-balance sheet derivatives. "Users do not want to wait for system updates, when a new security gets invented," says Bara-nack. "There was a time when if you had a mainframe or midi range and a new security came on to the market, then you would have to wait for the vendor to program how to account for it. Our current system has been designed and built for flexibility. A security is nothing more than a series of cash flows and you can model the cash flows within PAM and it handles the accounting and reporting from these.

In addition to the established range of portfolio management functions, easy access to critical investment decision-making values, such as yields, duration, convexity and so on, on both a position and portfolio basis, is a feature of the PAM system. "What is important to users is how quickly they can get good analytical data, without having to wait for someone to program it for them."

According to Baranack: "PAM takes all of the old issues out of the picture - such as not having to export that from the system or import this, reconcile that, 'how do you know which data is right?'." And the fact that it is distributed processing means that everyone gets the information quickly and accurately. "The key is pushing down access to the desktop" - getting information into and out of other systems and being able to work with the different systems people are using such as Barra, Bloomberg, Portia and so on.

But it is not just system suppliers that are making strides here. Citibank Global Asset Management in London believes it has developed a system that can add value to its asset management services to clients and is finding a ready appetite for what it offers.

Peter Fegelman is head of derivatives on the asset management side, which explains much of where Citi-bank came from. "As a global asset manager, we needed a system to go across the different asset classes, as we wanted to integrate derivatives through fixed interest, equities, foreign exchange and other markets."

Having abandoned the attempt to build a system in-house, Citi-bank purchased the Riskwatch system from Toronto-based developer Algorythmics. "This was primarily de-signed for risk managers. We believe we were the first investment manager to buy it."

For the bank, the critical factor was to be able to look at the impact of derivatives on a portfolio. But Fegelman found he had a robust tool that could be expanded and integrated to become a valuable asset mangement information system, although only after considerable time, effort and resources were put into it.

Riskwatch has all the functionality expected of a full portfolio management system. "The power of the software is that it has everything integrated, the factors that affect prices and positions and the models which translate that into price behaviour."

Riskwatch has a broad library of theoretical models, and Citibank helped adapt these to the needs of an investment manager. "We can create scenarios and look at their impact." This is not just in relation to equities and fixed interest portfolios but also where derivatives are included. The option models include Black-Scholes, binomial lattice, Black, Barone-Adesi and Whaley and Hull White.

"We are finding that it is a really robust tool, so we can change parameters such as yield curves, volatility curves, FX rates, prices and positions, and look at what happens over time."

He says customers increasingly look for information on the risk and return aspects of their portfolios. Now, for any portfolio mix, different scenarios can be shown and the effect on the risk and return. "Relatively accurate estimates of risk and return can be made particularly in relation to derivatives where you can quantify the exact impact."

When the global asset allocation commmittee generates its return forecasts for different markets, how that affects the behaviour of individual portfolio can be assessed. "And we can also see what happens if we are wrong the other way" says Fegelman. For a given scenario, the program can be used to alter the portfolio mix to reduce risk relative to expected return. Another aspect in which Citibank expects there to be much interest is the ability to create distributions using Monte Carlo simulations. "This gives us the ability to estimate returns over a given horizon for a specific portfolio." Fegelman regards this as the state of the art in risk management and enables value-at-risk (VAR) to be calculated. "You can work out the worst-case loss in a probabalistic sense. What this is meant to take into account is the volatility in the underlying assets, as well as the correlation between them."

A number of institutional customers have already asked about the ability to limit risk specifically on the basis of VAR. "They do not want the risk of portfolios losing, say, 100 basis points to be more than 2.5% for a given horizon. We can manage that and if our VAR estimate is greater than 100bp, obviously we have to alter the portfolio mix."

Institutional investment clients are obviously becoming more interested in having more sophisticated analyses of their portfolios, as Citibank is finding. And at Princeton, the need to have more modelling capability is currently being addressed. Baranack says: "This is something we have at a minimum level - being able to put in model portfolios and compare against the model." He describes the area of "what-if" scenario modelling as being "a little basic". "But we see it as something that we are really pushing more functionality into." The object linking and embedding technology incorporated in PAM should play a part here, he adds. "VAR analysis is something we are working on, but we do not have it right now."

Baranack believes the marketplace is going to evolve so that the information technology delivered will be a crucial factor. If the investment manager can give the client all the information that he requests for analysis, then value is being added. "What can you provide to your client that will add a few more basis points?" More and more clients will choose their managers on the basis of the technology levels."

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