Assembling the Risk Puzzle
Apr 14, 2006
URL: http://www.wallstreetandtech.com/showArticle.jhtml?articleID=185302815
Furnishing investors with a timely, accurate and sophisticated picture of risk in underlying funds may not be an overwhelming task for firms that manage all their funds in-house. But for a firm such as New York-based Fairfield Greenwich Group (FGG), a manager and provider of alternative investments that also makes some external hedge funds available to its investors, providing the same intensive risk management overview takes considerable coordination.
FGG manages more than $9 billion across 30 private hedge funds. Those funds consist of single-manager funds (more than $5 billion in assets under management), multistrategy funds (more than $1 billion) and funds of hedge funds (more than $2 billion). To facilitate a holistic view of risk, FGG requires that its underlying funds afford a high-level of transparency so data on their positions can be aggregated and fed into systems for fund and firmwide risk and compliance assessments.
To accomplish this, "What they need on a consistent basis are statements from the hedge funds," says Denise Valentine, senior analyst with Boston-based Celent. "And what they have to cope with is the fact that there will be various degrees of automation with each hedge fund -- some will send flat files, some will send XML and some are more sophisticated."
For FGG, that data collection is achieved in many ways. "We receive the data any way we can get it -- meaning directly from the managers or their prime brokers, or our administrators," says Jason Elizaitis, FGG's director of IT. "We aggregate a tremendous amount of data to power the risk systems."
Currently, the firm uses two primary methods to aggregate data, however. The first is via direct pipelines from eight prime brokers, some of which handle multiple FGG funds. At the end of the business day, different divisions within the primes deposit files -- including transaction files, position files and gain/loss files -- to the firm through file transfer protocol (FTP) sites.
FGG also collects data directly from the underlying managers and administrators. Again, the firm's risk group works to reconcile the multiple sources of incoming portfolio information to make sure the data is clean. In fact, FGG often prefers to receive information on its underlying funds from the third parties with which it works, rather than directly from the funds themselves.
"Independently receiving portfolio information from the managers is critical for our investment-compliance and risk-oversight function," according to Amit Vijayvergiya, head of risk management at FGG. "We rely very heavily on what we receive from those independent sources -- whether they be administrators or prime brokers." Information received directly from the managers augments the third-party data, he adds.
Prime Challenges
But the main data-collection challenges for FGG arise not from a lack of automation among managers, but rather from the diversity of technology among the prime brokers. "You need a system that will aggregate from multiple parties in as automated a fashion as possible and as flexibly as possible because these parties have different technology structures," says Celent's Valentine.
For example, FGG's Vijayvergiya says, in the past, a prime might send 10 separate files -- one for cash, one for swaps, one for derivatives, one for foreign exchange, etc. Collecting these disparate files from an FTP site was an onerous task, he notes. "We would have to build maps and aggregation algorithms to pull all that information together into a usable file that can feed into a securities master," Vijayvergiya explains.
So the firm has been working with those primes to reduce the number of files to one or two. "Some primes are much better than others in this regard," Vijayvergiya says. "But the ones that needed some improvement, we've had to work with," he notes, adding, "I'm particularly noticing within the last six months a willingness from some of these primes to provide data files in a format that is usable."
Charles Oddy, FGG's senior risk officer, notes that, in particular, he's seen improvement among the primes that the firm deals with in Asia. "[That's] made a big difference in our analysis of, and our coverage of, some of the instrument types on these Far Eastern hedge funds," he says.
Keeping Track
FGG uses a number of tools to track and evaluate investment vehicles and managers. The firm has tools that are used for basic statistical risk-return profiling and historical performance analysis, "and then we have some very sophisticated tools on the risk-monitoring and oversight function," says Vijayvergiya.
One of the main tools, called CAI (developed with Burlingame, Calif.-based Cogency Software), allows the firm to process the collected information, add additional terms and conditions or market data, and perform data scrubbing and reconciliation. Then FGG is able to "present a portfolio at the end of every day on what our holdings are and marry that with other market fields," explains Vijayvergiya.
CAI's investment compliance module helps FGG ensure that its managers are adhering to their mandates on a daily basis, in terms of staying within certain concentration limits as to instrument type, market capitalization, sector, industry or other parameter. The firm also monitors certain portfolio activity or turnover limits.
All the information that is collected through FTP sites and other means is rolled up into the module, aggregated and fed through the platform, which then produces reports at the end of each day alerting the firm to what it terms yellow and red thresholds. "It's very useful for us because it allows us to stay very proximate to the portfolios and effectively utilize the raw, position-level data, synthesize it, efficiently aggregate it, and then represent it in an efficient and scalable manner," Vijayvergiya relates.
Jeffery Axelrod, chief technology officer with Cogency, says that investors want to know that underlying hedge funds are sticking to their investment mandates. "If one fund of hedge funds has a sloppy Excel spreadsheet and another has a nice system to be able to show some degree of transparency or at least the compliance piece -- weekly or monthly -- to their investors, that might look better to a prospective investor doing due diligence," Axelrod points out.
CAI's second module, which is populated with the same data, handles portfolio oversight. The data compiled in the module is presented in a security table featuring performance indicators, summary statistics, concentrations of top holdings, concentrations by sector, and industry and credit ratings. When the FGG investment group arrives at work, each member can monitor the funds for which he or she is responsible.
Driven to Excel
Though often disparaged as an example of an unsophisticated IT solution, Microsoft Excel does have a place in the world of hedge funds and, in fact, in FGG's world, according to Vijayvergiya. Excel is useful, he explains, when the firm wants to conduct one-off analytics -- to glean the type of associations that might be found from data in the managed portfolios or from market data.
For example, FGG uses the ASP version of the RiskManager product from New York-based RiskMetrics Group to conduct aggregated and position-level risk analytics on a monthly basis. There are a number of different reports that the company will run to provide a sense of the market risk around its managers' positions. FGG dumps the risk statistics or position-level reports into Excel and then conducts its own analytics outside the functionality offered by RiskMetrics.
"Excel is a tool that is very useful for us to do additional analysis, exposure reporting or comparison, historical trending of our managers to other managers, or to the managers themselves at different points in time," Vijayvergiya explains. An example of an inefficient use of Excel, he continues, would be hedge funds that rely solely on the Microsoft application for basic statistical analysis -- such as Sharpe or Sortino ratios -- that can be handled better with off-the-shelf software packages.
In fact, FGG works closely with software vendors as the technology providers develop and improve their products to make sure FGG can get the most out of off-the-shelf solutions and ensure its particular needs are being addressed. "They've been flexible enough to incorporate some of the suggestions we've had to improve the products and make them more useful for us, and they're getting feedback from the front lines with respect to what their client base is looking for in a product," Vijayvergiya says. "So I think it's been collaborative and mutually beneficial." <<<
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