Ten years on – When it comes to risk, one size never fits all
As with previous crises, 2008 was a catalyst for many changes across the investment industry. Some of these were knee-jerk reactions, others more fundamental changes to business, regulation, investor protection and transparency. Investment risk is one area that has seen significant change, but at the same time, has also remained bogged down in details and data. In this post I focus on some of what has changed in the last 10 years, but more importantly outline where more change is necessary and likely to come.
Single to multi-dimensional risks
So, what has evolved the most? Firstly, risk has been dragged out of the backwater and into the executive mind thanks to regulatory change, client expectations and investment philosophies. Risk is no longer just a ‘tick-box’ exercise or calculating a single risk number (e.g. Value-at-Risk). Risk managers are now expected not only to compute risk, but to attribute and explain it—to dive beneath the surface and bubble-up any unexpected risks and unwanted exposures.
If 2008 proved one thing, it was that an effective risk framework had to include multiple dimensions of risk, different lenses, and the ability to test portfolios for out-of-sample scenarios and ‘Black Swans’. Stress tests—lots of them—are now critical: replaying historical events, employing factor-based scenario analysis and propagated (transitive shocks) using a risk model. The more stress tests can be run, the more the edge events that can cause unwanted outcomes can be identified, hedged or mitigated. The on-demand power of cloud-based systems now enables the kind of burst computing and calculation scale otherwise impossible 10 years ago. Historical stresses can be run on the fly, portfolios changed and risk re-run. No longer are we locked into one risk-batch per day.
Let the integration begin
In the aftermath of 2008, investment managers could not have too many risk systems. Budgets were found and risk and compliance were “must-fix” functions. In 2018, a different paradigm rules: manager consolidation, margin squeeze, cost pressures, headcount reductions and a search for efficiency. Consolidation of multiple overlapping risk platforms is healthy and to be welcomed. It is no longer good enough to run equity risk on one platform, fixed income risk on another and derivative exposures on another. Cross-market relationships, especially in stress environments, must be measured, with exposures to entities across asset classes quantified and managed together.
From an investment perspective, the march of passive, ETFs and factor investments has driven another wave of systems change—from platform improvements, API-integration and portfolio construction to factor optimization—all of which interact with risk.
Struggling with the pace of change
A separate but a related area that needs more attention is data and technology. Incumbent legacy systems—meaning installed software on expensive hardware stacks, with costly upgrade cycles to both—have lagged the pace of technological change. Modern computing has come on in leaps and bounds, with cloud computing, elastic scalability, open APIs, microservices and interactive visualization but too many risk vendors are still living on yesterday’s technology (if not 1990s technology).
The cloud, however, has now been embraced in terms of market adoption and acceptance. Switching wholesale infrastructure and software models might be scary in the short term. But the benefits far outweigh the liabilities of being tied to infrastructure that hampers change and consumes both budgets and headcount, not to mention preventing investors from reacting quickly enough to market changes and client demands.
Can you have it all?
If we look at what’s next, there is an ongoing search for the ‘Holy Grail’—one platform to do everything.
Like the Holy Grail, this perfect platform is elusive, at least for the practitioners looking for best-in-class in each of their respective areas: trading, risk, performance, compliance and reporting.
Each area has specific requirements, and each investment manager is different. A cookie-cutter approach doesn’t work. Practitioners need flexible systems that can be tailored to their investment philosophy, their investment process and their workflow. In the next generation of risk platforms, openness and integration are key. They must be able, nimble and flexible enough to connect with other investment platforms and portfolio construction tools—and ideally at API level, not just antiquated flat-files.
That’s where Axioma’s solutions come in: Flexible and cloud-native, our multi-asset risk and performance engine is now available with interactive reporting. Contact us to learn more.
The future is here.