Justin Wheatley explores why performance measurement and attribution software are crucial resources in the asset management revolution
Within Europe and around the world, the asset management industry is currently undergoing a revolution as significant as anything in its history.
The ready availability of investment funds stemming from a decade of steady economic growth; dramatic increases in the demand for cross-border investment resulting from a very reasonable belief that foreign investment is essential to maximise the effectiveness of risk/return profiles; the perception by an increasingly broad section of the population that stock market investment in the long run offers the best return on invested money and positive publicity relating to high-growth start-ups. These and other factors have played a role in causing a surge in the amount of funds available and a corresponding significant increase in the demand for expert asset managers.
It is not easy to be definite about when the asset management revolution started. What is certain is that the industry has experienced 25 years of sustained growth. The past decade has been a time of particularly vigorous expansion for the industry, especially in the area of cross-border investment, and it is showing no sign of slowing down.
The existence of the asset management revolution can be proven numerically by quoting figures that show clear and lasting increases in the amount of funds under management in different countries. But the real ramifications of the revolution need to be observed at a more subtle level. Viewed from this perspective, it is clear that in tandem with the continued surge in growth of the asset management industry, there is a corresponding surge in the efforts of asset managers to develop greater professionalism, a greater understanding of their own operations and the factors that help them to be efficient.
Above all, there is a desire for knowledge on the part of asset managers of exactly where and how they can maximise performance of the investment instruments for which they are responsible.
Asset managers and, more importantly, their clients have started to realise that some of the practices that were acceptable when companies managed a few hundred million dollars up to $1bn are definitely not acceptable when the organisation is managing $10bn up to $100bn. There has, in the past, been a curious informality to the way asset managers operate, an informality that has even been noticeable within asset management organisations that are extremely successful in terms of profitability and in maximising the performance of funds under management.
This informality has sometimes manifested itself as a somewhat dilettante approach to the business of asset management, a 'gentlemanly' unwillingness to accept that asset management is inevitably an ultra-commercial business in which nobody takes any prisoners and where only the truly intelligent, knowledgeable and switched-on are likely to succeed. This approach may to some extent have been reasonable when the industry was more contracted and more domestic than it is today. In 2001, however, an asset manager which seeks to pretend that it is involved in a dilettante and informal business is courting disaster.
The days when the clients of asset managers were similarly gentlemanly and informal in their approach are over. The new kind of client ' whether a newcomer or a traditional player with new attitudes ' is unlikely to care greatly about the complex strategic issues which impinge on their fund's performance. Instead, they will want to be certain that the asset manager they are dealing with is a real winner.
How can they know this? Only if the asset manager can support claims for excellence of fund management with systematic and rigorously-produced figures which not only stand up to scrutiny, but are also derived from a standardised approach to collating the figures which allows clients to make effective comparisons between different asset managers.
Ever since the introduction of Global Investment Performance Standards (GIPS) on 1 January 2000, a framework has existed for allowing information about fund performance to be standardised and to enable clients to make comparisons between one asset manager and another. GIPS is currently being implemented worldwide, sometimes by national frameworks which give it a different name. However, the provisions implemented at a domestic level are all GIPS compatible. There is no doubt that the introduction of GIPS has also created a revolution in the asset management business: a revolution where, for the first time in the history of institutional investing, everyone is playing on a level playing field.
But an asset manager can only make effective use of GIPS to allow existing and potential clients to obtain a true profile of its investment strengths if it knows enough about its performance to provide this information in the first place.
One of the most immediate consequences of the fundamental revolution in the demand for asset management services has been an intimately related new level of demand for analysis relating to performance measurement and performance attribution.
At one level, the questions this analysis must answer are straightforward: how are our funds performing? and what is the basis for this performance? The questions might be straightforward, but the numerical investigations necessary to answer them are far from straightforward. Indeed, the sheer number of accounts/ funds/equities/bonds which an asset manager is handling means this analysis is in effect impossible without good performance measurement and performance attribution software.
How is an asset manager to obtain access to the kind of software necessary? One solution is certainly to develop it in-house. It is possible that a very large asset manager will have the funds and the resources to deal with possible delays and even failed projects which would make this option feasible, but it is only likely to be the very largest players which would even want to contemplate this particular route. Anyone involved in in-house systems development knows the risks of trying to build a system which while certainly unique to the organisation, may conceivably turn out to be unique in the problems it brings.
A more realistic alternative is to opt for a packaged solution that has the extremely significant advantage of being tried and tested. The asset manager can then very reasonably expect that reference sites will be available. Furthermore, the vendor of such a package will, in effect, be able to spread the development costs of the systems across a number of customers, thereby bringing the price down very significantly from that likely to be attached to an in-house fully-tailored system. There is no gainsaying the fact that in principle a packaged system will not necessarily be unique to one particular organisation, but any vendor worth its salt will find ways of customising the system to the user's particular needs.
Besides, there is the argument that in the case of a performance measurement and attribution system, intense customisation may not be as important from a competitive standpoint as it might be for other systems. The point is that the system is designed to generate the information that will help the asset manager compete against rivals.
It is essential the system generates this information accurately, rapidly and with all the necessary levels of functionality and specific requirement, such as for customised reports. As long as the system does what is required, the asset manager can be confident that the right information is being gathered within the system to show the asset manager to its best advantage, given the increasingly important demands of GIPS for the information to be gathered and presented in such a way that it allows effective comparisons to be made. As far as implementing the software necessary, there is no time like the present.
An important final point is that asset managers are making more and more use of the procedure known as 'daily stock level analysis' ' a sort of 'nuts and bolts' daily measurement and attribution discipline which is no less important for being highly practical and 'hands-on.' It offers asset managers the ability to understand very clearly what stocks are actually adding or detracting from their performance. This gives the asset management organisation the corresponding ability to identify those in the organisation who make the right decisions and reward them. Ultimately, asset management is driven by the engine of research. The beauty of daily stock level analysis is that it makes it possible to work out what the research has added from a stock-by-stock and portfolio-by-portfolio point of view.
From the asset managers' perspective, the prime commercial driver for implementing performance measurement and attribution software is the need to comply with GIPS legislation and present a firm-wide perspective on performance issues. There are, however, other important drivers, namely:
Dramatically reduced costs compared to the expense of preparing this information manually. In practice, it may not be possible to prepare the information manually in most organisations due to its sheer complexity.
Accuracy of published figures ' asset managers cannot afford to make mistakes.
Prompt reporting of figures. Some investors are insisting on prompt reporting as part of the service; not providing this could lead to business being lost.
The fact that the software helps the asset manager to understand and explain the investment process and its results.
Pension fund trustees are under an increasing responsibility to achieve good performance in order to show that they have properly discharged their duty of care.
Pension funds are, of course, a major source of revenue for the majority of asset managers and being able to prove quality performance to pension funds is an absolutely essential element of maximising profitability.
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