The Challenges of Supporting
New Investment Strategies

The past year saw investment management firms undergoing radical changes in the way they invest and in the securities in which they invest. The widespread adoption of multi-asset investment strategies, the aggressive push into alternative assets, especially hedge funds, and the huge growth in derivatives has strained the systems, operational processes and resources of asset management firms.

Impact on Systems and Operations

Traditional systems used by investment firms have either a long equity or fixed income orientation and have been unable to effectively handle multi-asset strategies, hedge funds and derivatives. While there have been specialty systems developed for hedge funds and systems retrofitted from the sell side to handle derivatives, many in the front office have developed their own departmental solutions, often in Excel, to meet their investment analytic needs. Although spreadsheets have always been in wide use, their proliferation, especially for mission-critical investment functions, is on the rise.

Solutions that have been developed outside the discipline and governance of established IT process have resulted in elevated operational risk. IT departments are balancing the need for nimble, home-grown solutions with the pressure to respond to regulators who are calling for reduced risk. In the end IT departments must demonstrate the value of more formal controls and the long-term cost benefits of tighter governance. Senior executives need to manage expectations for achieving an appropriate balance of technology capabilities progress while maintaining control and regulatory compliance.

One firm CutterResearch™ recently interviewed openly embraces the broad use of spreadsheets. This firm is undergoing major upheavals in their organization and in the products and the markets in which they invest. They believe that harnessing the power of spreadsheets is the only way they have a chance of their systems keeping up with the business. This firm has created new policies to support end-user computing, hired staff to assist end users, defined audit requirements for end-user computing, and created quality control procedures for spreadsheets (including testing and versioning). Business users are very receptive to this plan, and the greatest challenge is in convincing various auditors that spreadsheets can be properly managed.

Regulatory Burden Continues

A survey of 30 global asset managers conducted by CutterResearch confirmed that in 2006 insuring compliance with a broad range of complex regulatory requirements continued to consume a huge share of IT budgets. This trend is expected to continue in 2007 with the impact of Reg NMS, MiFID and other regulations. The conundrum for the heads of investment systems and operations is that the cost of meeting regulatory requirements draws scarce resources away from upgrading or investing in the new systems needed to satisfy changing business requirements. Even though 2006 budgets increased, survey participants reported that frequently there was inadequate funding to support fundamental changes to the business.

The challenge for 2007 is more daunting because regulations are expected to consume an even greater share of IT budgets. In 2007 CutterAssociates™ anticipates that regulators will continue to push for transparency, efficiency, integrity, and convergence of global regulations.

Derivatives Proliferate

The explosive growth of OTC derivatives poses enormous challenges for systems and operations:

• Firms are racing to address the huge back log of derivatives trade confirmations, which is a huge source of operational risk
• The custom nature of transactions makes the tracking of trade details, master agreements and collateral agreements extremely difficult
• Black box pricing models lack automation and transparency
• Collateral management is cumbersome