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Magazine Issues » Dec 2008-Jan 2009


Multi-asset classes and funds of funds have made performance attribution more difficult. Lynn Strongin Dodds finds that advances have been made...

Performance measurement and attribution for multi-asset class structures or funds of funds has never been an easy task and in today’s turbulent financial markets there is even greater attention paid to it. Institutional investors are increasingly turning to third-party participants to provide them with the finer details about their portfolios. 

Fraser Priestley, EMEA managing director for performance & risk analytics at BNY Mellon Asset Servicing, says: “One of the major trends we are seeing is that trustees are asking to see summary board-level reporting that provides the key information they require to evaluate their investments.

“They want the major points highlighted, the risks explained and what the current disruption in the markets means for their investments.”

One of the biggest problems for on multi-management front, according to Carl Bacon, chairman of StatPro, a data and software firm, is assessing the different methodologies that are used to fit the different asset classes, whether fixed income, equities, currency overlays or derivatives.

“They each have their own characteristic, and the more complex the strategy, the more complex the tools need to be,” he says.

Critics say that the performance measurement industry has been slow to rise to the challenge, taking its time to spawn a new generation of products. Although the days of spread-sheet calculations should be long gone, many systems have still been geared towards multi-asset class structures that translate only into equities, fixed income and cash.

They did not factor in the burgeoning alternative asset classes such as private equity, hedge funds and real estate that fund managers were adding to their repertoires.

Nor did they account for models including the more complicated strategies – such as liability-driven investment, equity long/short and absolute returns – that institutions were using to achieve a better match between assets and liabilities.

Andrew Sherlock, a management consultant at Citisoft, says: “Over the past few years we have seen a huge amount of specialisation and the evolution of best-of-breed approaches. Institutions tend to set policy at the macro level and allow highly skilled and focused fund managers to implement within the stated boundaries.

“To measure the fund managers’ success, more sophisticated and complex risk and measurement models have been developed to better reflect the investment processes.”

Another motivating factor that has caused providers to evolve their systems is the clarion call for greater transparency through, for example, the wider adoption of the Global Investment Performance Standards (Gips) – voluntary industry-wide standards that require managers to provide a standardised presentation of fund performance.

Today’s performance and attribution systems can cope with clients’ demands for more frequent reporting – from quarterly to monthly or daily measurement  – as well as the increased level of detail and depth of information. In addition, there has been development in the fixed-income attribution sector, to better reflect the investment process as well as separate calculation methodologies for private equity and property.

Clean data
Despite the progress, though, strides still have to be made to improve these offerings. All agree that the biggest challenge remains the quality of the data and whether it is clean enough to create accurate returns.

Underpinning performance and attribution systems is the accuracy, timeliness and depth of the information received. Fund managers have to explain their positions early and as quickly as possible and they need the right information. This is one of the main differentiating factors between the systems.

This is particularly true in a fund of funds vehicle, according to Tim Miller, European director, SunGard’s Asset Arena. “It is important to have timely price information because fund managers are buying and selling the underlying holdings of these structures on a regular basis. In the past, with a single fund, it was easier to identify which were the ten top and ten bottom stocks. Now we are talking about a constantly moving target which adds another layer of complexity to the process.”

Miller also believes that more work is needed on the fixed-income attribution front. It continues to be the thorn in the industry’s side due to a wide range of instruments that include interest- and inflation-rate swaps.  Extracting the data out of the accounting systems needed for the calculations can be difficult and models used for equity attribution simply cannot be reconfigured for their fixed-income counterparts. They need a more bespoke approach. 

“The equity attribution side is quite straightforward and the methodology is fairly standard,” says Miller. “This is not the case in fixed income where there is no ‘one size fits all’ model. “There needs to be different models for the different instruments and management styles.  Many vendors have tried tackling this area but they have not succeeded because there is no one model for fixed income instruments.”

Another tricky area is hedge funds, where valuing a portfolio can include options, margin borrowing, long as well as short futures and a market-neutral strategy. Even before the sub-prime calamity exploded into the current financial crisis, investors were demanding better performance measurement tools to pinpoint the leverage being used in funds and other relevant risk data. Gips, which covers the bulk of the issues, is looking for a solution but the main roadblocks have been the hedge fund community’s unwillingness to provide information or use a benchmark.  This may change going forward as a significant number of hedge funds have been hit hard by redemptions and are struggling to stay afloat.  

Identifying risk
Looking ahead, not surprisingly, risk management has risen to the top of the agenda and market participants foresee a greater convergence between these processes and performance measurement and attribution systems. For example, ex-ante risk may become an embedded tool within packages. Performance attribution looks at the drivers of performance over a given period and decomposes a fund’s added value in relation to the investment policy benchmarks. This analysis provides insight into the strengths, weaknesses and consistency of a manager’s decisions by clearly identifying the source of the returns generated, whether from asset allocation, security selection, interaction effect or currency effect. 

By contrast, predictive risk addresses the way the market can impact positions within the portfolio and focuses on various risk factors such as spreads, individual equity prices, volatility or basis curves.

Overall, Bacon believes there will be a growing demand for this type of package. “When times are tough, investors want more information and analytics to be able to differentiate between the different managers. They not only want to know the sources of their returns but also where they lost money. As for the fund managers, they need to justify their strategies and to demonstrate that they are measuring and controlling risk.”

Holding still
At the moment, though, many investors are weighing their options and sitting on the sidelines. The diversification benefits of a multi-asset or fund-of-funds structures have not been lost but institutions are uncertain as to when to wade back into the markets. As Ron Tannenbaum, co-founder of GlobeOp Financial Services, says, “Industry-wide, investors are reluctant to commit new capital. The trend is a slowdown in asset allocation to new funds as well as a drawdown in funds of funds. Institutions are building cash reserves and we believe this will lead to a pent-up demand next year. When they do commit new capital, it will be faster than people think and across the entire alternative investment space – hedge funds, private equity, real estate and so on.”

©2008 funds europe