As publisher of asset management software and privileged partner of asset management companies, BSB follows the latest trends in asset management
For the moment being, the financial world goes through one of its toughest crises, generated by the « subprimes ». However, it is not the first time that the financial world experiences a hard time. In 1636, Amsterdam lived the first financial ‘bubble’ generated by pure price speculation on the price of tulip bulbs. A lot of people had taken on too many debts in order to buy on an early forerunner of the « futures » market the most beautiful tulip ever, the famous so called « semper augustus », which was then an external sign of wealth. Worth about 1.000 florins before the speculation began, its price went up to 5.500 florins before collapsing in a couple of days. At the end, the price has lost 90% of its value. And of course, the Crash of October 1929 still haunts the collective mind. This crisis extended to a general economic crisis that only got absorbed at the beginning of the Second World War. The Stock Exchange hit the bottom in 1932 after having lost 89%. It would take 25 years, until 1954, before the Stock Exchange had reached its level of before the Crash.
From that moment on, the fund managers became increasingly aware of the risks of important financial losses. In the 80ies, « portfolio insurance » was ‘hot’. The objective was to protect one’s portfolio(s) by buying put options, i.e. options giving right to sell actions. Of course, in case of an upward trend of the market, this could have a negative impact on the option premium you paid, but in case of a bear market, you were pretty safe. At that time however, the options market was far from being as liquid and efficient as today. The gaps between buying and selling were very important and the price for security high. As a consequence of that, the managers stopped buying puts and covered the delta by buying shares. In 1987, the dollar price was subject to numerous and important fluctuations due to the anti-inflation policy led by the FED and the sudden rise of the interest rates on the bond market. One day, the Stock Exchange lost more than 22% in one single day. The sudden increase of the deltas to be covered, along with the collapse of the prices, generated automatic selling orders which considerably amplified the plummeting of the markets, which generated an increase of the deltas to be covered, and so on and so an. The Asiatic economical crisis of 1997, the internet bubble of 2000 and their effects on the financial markets were additional factors that have marked the financial world and made it evolve towards new asset management techniques.
However, controlling the risks and reducing the potential losses are far from being new topics for financial institutions which have created « risk management » departments since long ago. Sometimes, you saw managers of those departments rush into the trading room, giving a reprimand to one of their traders who had exceeded his limits. Not that he felt very concerned by it, because once his boss had turned his back, he just went on with his activities as if nothing had happened! In fact, the traders had only two things in mind: make a lot of money and get a big, fat bonus at the end of the year.
Since then, regulators have taken over the role of these ‘risk managers’. They also made people aware of the big risks by introducing new management and reporting requirements, based on the apprehension of risk and on risk reduction. Basel II and Solvency II are both clearly oriented towards a more sophisticated risk management.
Moreover, the « management style » itself goes through profound changes. Risk indicators have become an important tool for managers. Before executing a transaction, they simulate the impact of a transaction on those indicators. This change in style is reflected at several levels: the content of classes at the university and commercial high schools have already integrated these concepts ; more and more of our current clients use risk and performance modules; about 70% of the requests coming from prospects point out the importance of risk management and analysis, whether « ex-ante » or « ex-post ». These risk indicators are not only needed for reporting purposes but must also be shown on the managers’ screens.
Indeed, managers have more and more sophisticated needs in terms of risk management. Nowadays, a manager wants to be able to simulate his portfolio at whatever moment without being forced to launch heavy batch processings or submit it to important fluctuations of market indicators. A manager or an investor not only wants to know the performances of his portfolio but also be able to analyse it in all its details. This is where ‘performance allocation’ comes in. If the performance gives an idea of the realization of the portfolio targets with regard to a benchmark, the performance allocation justifies the performance gap with regard to a benchmark. The over/under weighting of a particular class of assets or securities, the currency effect, the positioning of the yield curve, the credit spread variation or the duration in case of a portfolio containing bonds, … they all explain why the performance of a given portfolio is different from its benchmark. More even, by allocating a global risk to the portfolio with regard to the securities it contains, the manager will not only be able to find the most risky assets within the given portfolio but also to simulate the impact of every new transaction on the total risk of the portfolio and to check how a new position will contribute to it.
Asset management will be more and more based on risk control. Every day, the manager will need indications regarding the Value at Risk (VaR) of his portfolio or the impact of his transactions on his Credit Value at Risk (CVaR). On a highly volatile market, the impact on equity capital (in case of asset management) or on client satisfaction (in case of fund management and private management) must be guided with a lot of precaution.
So, managers have started to appreciate those flexible functionalities which are no longer only applied in a static way to accounting data but nowadays also to management data. With the recent « subprime » crisis, even the diehards and the most ferocious opponents of risk analysis and allocation methods have to admit that they need these methods in their daily activities. BSB has always been attentive to these aspects of asset management which are already integrated in its Soliam software. BSB wishes to continue this integration of risk and allocation methods within its solution as well as improve its ergonomy in order to make the indicators and simulations more user-friendly.
Patrice Langlois - Consulting Manager - BSB
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