Hedge funds have learned a lot from the recent credit crisis. One lesson is to generate their own assessments of counterparty and other risk, as opposed to accepting the party’s data or an agency rating. Investors without the technology to do so are planning on getting it and those who have it are putting such platforms through all of their paces.
Out of more than 500 senior securitization market participants queried between June and September 2010, 90% had plans over the next two years to implement technology to improve analytical, risk and operational processes in managing Asset Backed Securities (ABS), Mortgage Backed Securities (MBS) and structured credit investment portfolios. The study, conducted by Principia Partners, a NY-based makers of Principia SFP, a platform for managing structured products, found that investors most wanted timely access and effective integration of collateral pool performance data for investment and risk analysis.
Principia and other platform providers, such as Imagine Software and Riskdata, are answering a growing customer demand for more sophisticated risk analysis they can control themselves. Steven Harrison, president of Imagine, which is introducing a post-crisis platform upgrade called Imagine 7, explains that “the structures that people thought they could trust in, such as rating agencies and the global banking system, failed and this led market participants to seek out independent risk systems to calculate their market exposures, in particular in the credit space.”
For Ben Parker, CEO of Sydney-based Arnott Capital, a US$50 million asset manager, attributes specific pieces of real time data, from his Imagine system, with fending off “panic around counterparty exposures.” He’s talking about the days not long ago when Lehman Bros. was failing and Goldman Sachs was being viewed by the market “as needing to do something to correct their balance sheet. There was no one position in our equity portfolio that could’ve lost us as much money as the counterparty exposure of a bank failing,” says Parker. “Basically, for the past two years we’ve had one eye on equity markets and one on counterparty risk.”
For the pricing information around the credit default swaps (CDS) Arnott uses, Parker says, he tended to ignore the slower moving agency credit ratings during the crisis, which “at the end of the day tended to be quite high for businesses that were (trading) around zero.” Instead, his traders combined three sources of data: Reuters equity prices now via the Imagine 7 system, with company balance sheet -- including the notes -- and other filings with Arnott’s own portfolio research, which includes talking to market participants. The heightened visualization functions on the new Imagine 7 also allow traders to drill down on a risk alert visible on a heat map for, say, a particular industry to see which positions and/or which stocks are most exposed. “All of our investors expect the traders to monitor like this,” he says. Arnott hasn’t had a loss in 11 years.
Post-crisis investors want to be able to see what’s next and test what-will-happen-if scenarios. “During ‘08,” recalls Mark Friedman, a principal in the mid-sized New York hedge fund, AM Investment Partners LLC, “large companies were failing left and right. But we could go in and look at the financial curve or gamma and ask, ‘how do we make money in this market.’”? To do that, Friedman, who has been using Imagine since he ran Deutsche Bank’s convertible arbitrage desk in ‘96, has always taken the software through its paces in ways the vendor never imagined including employing what he calls, “shocking.” His traders, mostly convertible bond arbitragers, run a lot of potential scenarios in real time -- or fast forward -- by ‘shocking’ the data. Then results are stored in a custom-made index of possible outcomes so traders can respond quickly to sudden market conditions.
“Risks are in any positions that appear to have convexity or are long convexity that after some type of dramatic move may no longer have that convexity or actually get shorted,” says Friedman. (Convexity can change with interest rate moves.) “I really don’t know of any other systems that can take a position dynamically, either in real time or going backwards or even forwards in time and enable you to look at that position and say ‘what if?’ What if the underlying moves 25% over night?” says Friedman, who wants to be able to calculate this way for any risks that are unintended. “The entire industry now is much more responsive to and aware of looking for these types of risks,” he notes. “’Unintended Risk’, that’s the big post-crisis expression now.”
Similarly, Verizon Investment Management Corp., Vimco, which manages the $49 billion benefits funds of the giant telecom and its domestic subsidiaries, just chose FOFIX, the risk management solution from Paris-based Riskdata, to manage the market risk of its absolute return strategies. The tools support its funds selection, fund monitoring and portfolio construction, and will report the risk assessments to the manager’s board. “FOFIX is used by our clients to assess managers’ alpha and to account for tail risk as well as to actively monitor exposures in extreme market conditions,” says Riskdata’s chair, Olivier Le Marois.
