The Modern Portfolio Manager Cockpit: Front-to-Back Portfolio and Risk Management
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In search of alpha, firms and investors are adding new asset classes and markets to their portfolios. But the buy side needs a system that can provide portfolio managers, regulators and investors with the required visibility into these products.
Investment management firms are facing a new reality. The current low-yield environment is forcing hedge funds and traditional asset managers to reach for innovative strategies in search of new sources of alpha. Constrained by increased volatility in major asset classes and lower expected returns over the long term, asset managers and their clients need to diversify their portfolios while reducing operational risk and improving compliance with global regulations.
To increase returns and avoid sharp losses, firms and investors are looking to diversify their portfolios, adding new assets where needed. There has been a great increase in alternative investments in recent years from traditional asset managers, showing the rising appetite for asset classes that have a proven track record in delivering returns.
[Related: “How to Build a Modern hedge Fund”]
The growing investments into emerging markets are another key example of asset class expansion. Investment firms require trading support in order to adhere to local market conventions across all geographical regions, particularly in Latin America, the Middle East and Asia. However, it is important for buy-side firms looking to invest in new asset classes or geographies that the system they use can handle these products with the required level of transparency and reporting mandated by regulators and investors.
Finally, as firms are trying to differentiate themselves to attract new inflows, there is a renewed focus for liability-driven investments and, more generally, outcome-based solutions. Plan sponsors are under duress and are showing appetite for such solutions. From the investment manager perspective, this reinforces the need for detailed, across-the-board exposure analysis and hedging functionality – in systems capable and scalable enough to follow the growth in volumes and complexity.
Total Visibility
The modern portfolio manager needs visibility, above all. Standalone legacy systems may not provide portfolio managers with what they need in this regard. In order to be effective, having a consolidated view of all positions and assets and being able to see P&L and exposures in real time is imperative.
More important, there is currently a shift of functionality from the back office to the front office. Collateral management, for example, is now no longer a post-trade process. Portfolio managers want to understand the impact of their trades on margin calls, or the impact of market movements on their projected cash. Investment accounting is also becoming more intertwined in the trade decision-making process – managers want to know in real time how a certain trade impacts their accounting P&L.
Finally, and more than ever, it is important for them to be able to simulate new assets and products to evaluate their impact on risk. Sensitivities, VaR and stress testing are key contributors to this analysis and to efficient portfolio management. Portfolios are becoming more complex and market conditions are more volatile, hence the need for integrated risk management in the investment decision process.
Global Regulatory Compliance
Since the financial crisis, and even in the years before that, there has been a rapid institutionalization of the hedge fund and asset management market. The pressure on compliance officers is considerable given the unprecedented amount of current and future regulatory activity, including UCITS, AIFMD, EMIR, MiFID and Dodd-Frank. Sophisticated investors are now demanding better reporting and deeper transparency from their investment managers, and increasingly perform in-depth operational due diligence. Regulators are also demanding greater transparency in risk management and reporting.
While looking to minimize the operational efforts to produce the reports, there are business opportunities for firms looking to attract new capital by following the “labels” of regulations and providing their investors with guarantees of compliance to best practices in investment management.
In addition, siloed business activities can create a higher risk of operational inefficiency. Today’s risk officers require consistent data and transparency across all of the organization’s business lines and need to be able to consolidate all the risks that might impact the organization. End-to-end integration and straight-through processing (STP) for central clearing are a big help in that area, as well.
Of note, another factor to consider is the increasing demand for managed accounts over the past few years. The financial crisis has left many investors nervous about comingled assets. Many now want their assets to be segregated. The operational burden of doing so can be significant.
Of course, costs are a big issue at a time when inflows are relatively low and margins are squeezed. Firms can benefit from a single, integrated system that covers all asset classes and is modular, with functionality that can be added on-demand with ease and has no redundancy. Hedge funds and traditional asset managers don’t want to have to develop their IT infrastructure themselves and want to rationalize the number of systems or interfaces. They expect service providers to develop new functionality to enable them to find alpha and grow, be more efficient, and meet regulatory challenges.