CutterAdvantEdge

Issue 50, June 2007

Industry Insights

An interview with John Clark, Principal, CutterConsulting™

Frequently, clients ask CutterConsulting for a real world view on what is happening in the industry. In the following interview, John Clark, Principal of CutterConsulting, offers his perspective based on his work with global asset management firms to resolve complex systems and operational problems.

Where are firms devoting the greatest focus in 2007?

John: The high demand has come from several areas that include:

Data management
Front office automation for fixed income, derivatives and alternative investments
Investment Administration Outsourcing
Regulatory changes

Data driven initiatives have seen a lot of traction in the past 18 months. What specifically is surfacing this year?

John: In our Assessment and Strategy practice we are spending the majority of our time helping firms in the areas of data management, focusing on process, quality and integrity. While most of the larger firms are well underway in establishing more robust data management capabilities, they continue to face challenges dealing with the more complex instruments including fixed income, derivatives and alternative investments. These asset classes are often processed outside in silos and manual workarounds.

As the search for alpha continues, what plans do firms have in place to address front office automation of fixed income, derivatives and alternatives investment strategies?

John: I wouldn't say just alpha but risk adjusted alpha. The largest challenge managers have today is a complete understanding of the implied risk in a given portfolio especially when they are investing in basket derivatives. Many systems are not able to properly represent the shape of the yield curve to the detail required for curve risk.

The other general need is to be able to have more robust 'what if' capabilities that enable you to run risk scenarios prior to implementing a trade idea. Currently, most firms can only run scenarios daily at best. While there are several systems that enable a manager to run intraday, the integration with intraday positions remains a challenge.

In the coming year I think we will see firms continue to move to faster access to portfolio risk data and attempt to bring the analytics and order management closer together. The vendor market is making strides to provide this but there will still be significant internal building happening as well.

As the options for outsourcing investment administration become more mature do you see this route as a more viable option for asset managers?

John: Outsourcing remains a high interest item as asset managers seek to reduce operational risk, gain access to offshore resources/pricing, manage escalating costs relating to Sarbanes Oxley, and lessen the dependency on finding qualified staff. The large custodian firms are beginning to better understand the needs of the buy side and are making some progress in establishing the infrastructure to support those needs. However, for this business area to be cost effective for both the investment firms and the outsourcers, the providers need to establish internal scalable systems and move away from lift outs.

As an aside, many of the front office vendors are now offering ASP services as well to meet the demands of smaller clients with little IT capacity. Another driver for this is the escalating costs relating to Sarbanes Oxley compliance.

There are so many external pressures driving initiatives. How are regulatory changes impacting asset managers?

John: On the regulatory front, Liability Driven Investment (LDI) is gaining traction in the investment processing space. Recent legislation in Europe and the US is requiring corporations to report unfunded liability data on their financial statements. This is creating a tighter connection to liability streams and impacting the investment goals of the asset manager. Our European clients seem to be farther along on this as they faced the regulatory changes earlier than the US.

While insurance companies have always had an acute focus on matching liability characteristics to the investment process, new legislation has brought this thinking into the institutional asset management area. Many firms are wrestling with defining and acquiring system capabilities to support this change. It is still not clear how much the asset managers have to expand their capabilities in the liability planning at this stage. Up to now, institutional managers have operated on total rate of return mandates. In the future, they will also have to pay attention to projected cash flows from the plan sponsors. It will be interesting to see just how far the asset managers will get into the liability business. In some cases, managers may begin to offer actuary advisory services along with the asset management.

What do you see on the horizon for 2008 budgets?

John: Spending seems to correlate directly to the health of the capital markets. Given that, we believe spending will continue to increase modestly in 2008. However, we are also seeing firms trying to be smarter about spending those dollars and they look to CutterConsulting to tie spending to strategic, rather than tactical, areas.

Firms continue to increase spending on regulatory compliance. With new projects going forward an additional overhead to remain in compliance has to be funded. In the past two years, development dollars for new capabilities have remained constant, and even declined slightly, although budgets have increased. The bulk of budget increases have been expended on the more intense focus on compliance.