Testing flexibility When Buy-Side Technology’s awards were advertised last autumn, a handful of technology vendors entered the same product into the portfolio analytics and risk analytics categories, illustrating the extent to which the flexibility of

Central to the job description of any buy-side portfolio manager is the need to choose securities that will advance the strategy of an investment fund. While in the past managers may have done this either by phone or with the help of basic portfolio analytics, there is a rising need to also make thorough analysis of the risks associated with the securities they are choosing to trade. That means that risk management technology can no longer be manufactured to meet only the needs of some quantitative risk experts in the middle or back office. It will be the systems that can be used across an organisation - by portfolio managers as well as risk managers - that are best positioned to gain traction in the years ahead. Vendors without such flexibility should think about creating it.

The analytics carried out by a portfolio manager have historically not gone beyond position-related information such as a valuation or the duration of a position, but risk analytics include stress-testing, modelling and other risk-related calculations. Few can argue that analysing risk at the point of portfolio construction is a bad idea and although fund managers are rarely experts in risk management, their superiors are asking that they pay greater attention to it. The rise of OTC derivatives and increased concerns about risk on the part of fund trustees, investors and regulators means that many managers no longer have a choice. Derivatives are perceived to be risky instruments and if the managers choosing to trade them do not assess the risk they are taking on, both their superiors and their clients may start to ask questions.

Yury Dubrovsky, chief risk officer at Lazard Asset Management in New York, believes that risk management should not be confined to a team of experts in the back office, and that portfolio managers should become more involved than they have traditionally been. "The reality of the buy side up until now has been that portfolio managers are responsible for return and don't take a view on risk," he explains. "But the one doesn't live without the other and portfolio managers need to realise that even though they create return, they also need to know what kind of risk they're sitting on."

Dubrovsky is in the process of installing an enterprise-wide risk management system at Lazard, which will be rolled out to 100 people across the organisation, including risk managers, portfolio managers and senior management. "I feel that my team should not be the lone interpreter," he explains. "Understanding risk needs to be part of the initial portfolio construction process."

The product he is installing, known as the Algo Risk Service, was developed by Canadian risk management vendor Algorithmics and was launched as a hosted service in June last year. For its part, Algorithmics says that the demand for a risk tool, that can also do portfolio construction, has driven the success of the product since its inception. Although it is known for its expertise in risk management, its flexibility and adaptability for the front office have made it more appealing. "It's fair to say that some people buy us strictly for the risk piece, but increasingly people buy us for the ability to support portfolio modelling in the overall investment process," explains Andrew Aziz, executive vice-president of risk solutions at Algorithmics. He adds that the ability to provide portfolio modelling tools alongside risk management, which the Lazard roll-out illustrates, has become the "principle value proposition" for the product. "There clearly needs to be a risk component to portfolio optimisation decisions, especially with the rise of more complex instruments, and our product is designed to provide that," he explains.

Firms like Algorithmics would perhaps like to be blazing a trail in offering a dual-purpose product such as Algo Risk, but other vendors - from risk specialists to front-office providers - are certainly hot on their heels. David King, head of Tiger Consultants, a UK-based buy-side focused consultancy, sees a widespread desire among asset management firms to bring greater risk awareness to their portfolio managers, but says the latency currently resides with the vendors. "We have come across several asset management firms who want their portfolio managers to pay greater attention to ex ante risk but it's a very difficult thing for the vendors to provide," he explains.

"There are traditional risk vendors out there and there are traditional portfolio management systems vendors out there, but neither has a track record for delivery, nor in many cases a wish to evolve when they go beyond their particular area of expertise."

Where a risk vendor may be accustomed to creating a product for use by risk experts, it may be less proficient in creating a tool to be used in the front office by a fund manager or a trader. Equally, a front-office vendor who supplies portfolio analytics may not be able to create an effective risk analysis tool as an add-on. The perennial question, therefore, for buy-side firms is which vendors they can trust to provide the best technology to satisfy both constituents. King also suggests that a firm with enough money in the budget might want to install both a risk system and a portfolio management system and let them fight it out between themselves.

As is so often the case in the financial services industry, the conundrum that faces the end users is met by a host of service providers scrambling for their share of the market. Paris-based front-office supplier Linedata Services is one such firm, working to adapt its Beauchamp FundManager product to meet the changing needs of the buy side. The product, which is the result of Linedata's acquisition of Beauchamp Financial Technology two years ago, is aimed predominantly at hedge funds and offers portfolio management and analytics services to 250 clients globally.

As Stuart Calder, head of product marketing for Linedata Beauchamp explains, the product is not currently associated with risk management in any way but that is something the vendor hopes to change. "Right now you'd be unlikely to see the Linedata name on any list of products defined as risk products," he explains. "But with portfolio analytics there is a clear overlap into the risk space."

The essence of portfolio analysis is, he believes, to choose the right securities to achieve a good level of risk as well as return, so risk analysis is inevitably part of the process. Calder reveals that a growing demand from customers has driven Linedata to look more comprehensively at risk analytics: "Investors now want more insight into what's in a portfolio and what risks are associated with that, so as a group Linedata is looking to increase its offering within the risk space during the course of 2008."

But Linedata's risk management functionality will be built into its offerings through collaboration with an existing risk vendor, rather than by building something up from scratch, says Calder. Although he declines to divulge further details for now, such an approach certainly seems to make sense in that Linedata is not going beyond its own expertise but will build out its offering through an alliance.

While Linedata grapples with the logistics of adding risk analytics, another service provider, within Swiss Investment Bank UBS, has also seen a changing use of its technology. The bank's web-based Delta product, first launched seven years ago, allows buy-side firms to manage their risk and achieve their performance goals by providing detailed analytics on equities, fixed income instruments and commodities. The product now has 200 clients globally, including both traditional asset managers and hedge funds. Dermot Shortt, joint global head of UBS Delta, says that while at first his clients were predominantly risk managers, he is increasingly now talking to portfolio managers. The product typically sits behind a buy-side order management system (OMS), from which it receives portfolio position data. "In the last four years we've seen a lot of risk management functionality move from the traditional risk management team onto the front-office screens," Shortt says.

The current reality in many large asset management firms is that portfolio managers will use a rudimentary version of a risk management system while the actual risk team may use the full service or several systems together to compare results and carry out more comprehensive risk analytics. Shortt says that in many instances the UBS Delta system now sits on the desktops of both portfolio managers and risk managers, but with different modules used in different parts of the business.

Incorporating risk analysis into the responsibilities of the portfolio manager may be a growing trend among asset managers, but it is also pertinent for hedge fund managers where fund trustees and senior executives are equally wary of OTC derivatives and are therefore keen that portfolio construction should include greater scrutiny of risk. King suggests that hedge funds may even be in a slightly better position to do this than long-only managers; where a long-only manager has to add both portfolio analytics and risk analytics on top of a standard OMS, hedge funds often take their technology from a prime broker's toolset, which is likely to already boast strong risk measurement capabilities. "A prime broker can offer all sorts of services, so hedge funds will use their trading tools, which generally integrate analytical and risk management capabilities onto one platform," explains King. "They are also doing straight trading rather than following a complex portfolio management process with several funds, so the analysis process with those tools is far simpler."

Hedge funds may have an easier puzzle to solve through their prime brokers, but vendors continue to court their business in this space. New York-based Imagine Software has built up its products to cater for the explosion in the hedge fund industry and claims to offer an all-in-one system that does everything a fund would need to do across all asset classes.

Chief executive Steven Harrison identifies three areas that are key to a hedge fund's trading process: portfolio management, risk management and analytics. "With a portfolio management system, you can book the trade, reconcile it and do P< with a risk management system, you can manage the risk of the instrument and for an analytics system you can theoretically price the instrument and do Greek exposures," Harrison explains.

"We're doing all these things that it might take three systems to do." The advantage of having all three functions combined in one system is especially beneficial within a small hedge fund where a trader might also do portfolio analytics and risk management. Instead of having to wait for trade data to flow between several systems, the trader can switch between functions whenever he or she wants.

Hearing the voices of risk vendors and portfolio management vendors, there is certainly a play-off of sorts between the two as both scramble for a piece of the other's pie. But setting that conflict aside, the reality of the current climate for buy-side firms - whether because of the credit crunch, the rise in popularity of derivatives or changing regulatory pressures - is that risk is becoming evermore crucial and the days when it could be managed by a few experts behind the scenes are certainly gone. In the years to come, firms will need risk management technology that is capable of sitting anywhere in the organisation. Some vendors are already providing that, but many are not there yet.

King sees this as an acute challenge for the buy side. "In my view the industry is in crisis on this at the moment because there is no clear direction as to what the market will look like in two years' time," he says. "It will take two years for the industry to react and provide coherent toolsets around the whole investment process to cover risk and analytics together." >