Derivatives and Investment Risk Solutions for the Buy Side

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13 December 2011

Optimizing the Risk-Return Equation


Protracted uncertainty in markets and asset prices have pushed investment risk management to the forefront. Buy side firms are looking to strengthen risk frameworks and systems to withstand future market turbulence. The need for a robust investment risk management system is critical to enable firms to achieve new levels of efficacy.

Structural market, regulatory, and business trends are now placing direct demands on firms to strengthen operational and technology underpinnings. Buy side firms looking to achieve best practices in investment risk management must adopt a highly cohesive approach to integrating investment risk management processes strategically into a firm’s portfolio construction, trading, and enterprise risk architecture.

In this report, Derivatives and Investment Risk Solutions for the Buy Side, Celent finds that crisis conditions, systemic disruptions, and regulatory changes (coupled with falling returns in traditional equities) have changed the long-term dynamics for buy side firms. Of more immediate importance to the financial markets is that many long-term investors have derisked their portfolios in response to regulatory and accounting changes, including a move towards mark-to-market accounting and stricter capital requirements, as well as a lower institutional tolerance for risk. This shift has led many institutions to increase their buffers of liquid investments—with some institutions shunning illiquid investments altogether and reducing the capital allocated to risky and volatile assets. At the same time, as investors are differentiating between alpha and beta, managers are forced to demonstrate positive alpha in uncertain markets, resulting in more firms utilizing derivative strategies to enhance investment returns.

“There is a clear focus on enabling and enhancing risk systems to measure and monitor market, counterparty, liquidity, and credit risk on a total portfolio basis,” says Cubillas Ding, Research Director at Celent and coauthor of the report. “The ability to monitor all exposures will allow firms to respond swiftly to any form of counterparty credit deterioration, while various functionalities such as liquidity risk management capability and a comprehensive set of risk analytics and attribution will provide firms with the ability to understand their liquidity risk and firmwide exposures at all times.”

“Front-to-back solutions, which can cover all departments across the investment risk management life-cycle, tend to be limited in their risk analytics capability. They often lack multifactor modeling capability, and, even if multifactor modeling is present, most solutions will only offer prespecified/structural models,” adds Sreekrishna Sankar, Analyst with Celent’s Indian Financial Services group and coauthor of the report. “By comparison, stand-alone investment risk systems allow for more flexibility and robust modelling capability, because users are able to make use of techniques of statistical modeling that allow for the estimation of systematic components obtained directly from historical data.”

As part of this study, Celent evaluated six vendors of investment risk systems, including Algorithmics, Calypso, Misys Sophis, MSCI RiskMetrics, Murex, and SunGard APT. Vendor solutions are ranked using Celent's ABCD Vendor View, which show the relative positions of each vendor along multiple dimensions: Advanced Technology, Breadth of Functionality, Customer Base, and Depth of Client Services.