Whether it's enterprise-wide, market or credit, in-house or outsourced, risk management is vital to the success of any firm in today's market. But when it comes to the risk needs of buy-side versus sell-side firms, there are some major differences that have led vendors to take sides, developing products geared toward one side or the other. Barra is one of those vendors with its TotalRisk solution, which is aimed specifically at buy-side clients. Barra's executive vice president Aamir Sheikh talks candidly about what the buy-side needs and why risk on the investment management side is unique.
The buy side may have previously been viewed as more performance oriented than risk oriented, but the last few years have seen a shift as firms are adopting risk management systems at a greater rate. "In recent years, this is a fairly big trend that we've been seeing," says Sheikh. "Risk management is being perceived as a prerequisite for gaining trust with clients. It's part of the branding of a good investment management firm--having good risk management in place."
And when it comes to systems that target the buy side, there are several unique elements that firms should be looking for and products to encompass, adds Sheikh. Aggregation is one of those key elements, being able to aggregate risk across asset manager and asset classes. "On the buy side, individuals and groups specialize and have a talent for their specialization and need to make reasonably autonomous decisions," explains Sheikh. "But those decisions need to be aggregated to look at the impact on an overall portfolio."
In terms of asset classes, the buy side typically may be dealing with not only domestic and international equities and fixed income, but also alternative investments such as real estate, private equity and venture capital. So risk must be pulled across all of these asset classes and aggregated accordingly, says Sheikh. Barra's latest client, the California Public Employees' Retirement System (CalPERS) is the nation's largest public pension fund with over $165 billion in assets across a broad range of classes.
Patricia Pinkos, senior principal investment officer at CalPERS agrees that broad asset coverage is vital for a risk management system. She adds that CalPERS was previously using disparate risk systems for each asset class and decided to pull them together with the TotalRisk system. "Each asset class had their own system," she explains. "But we wanted to find out what risk we had in the entire portfolio so that we could see if we had off-setting risk or compounded risk that we might not realize we were taking."
Additionally, the buy side is working within a framework of benchmarks, which is different from the sell side. "A U.S. value manager would be judged relative to a value benchmark, while a U.S. large-cap manager would be judged relative to a large-cap benchmark. So users need a lot of data on benchmarks. It is very important to the asset management community," says Sheikh. The time horizons used on the buy side when it comes to measuring risk management are also different than those utilized on the sell side. While the typical capital markets firm is working within the intra day and trading day environment, a plan sponsor on the buy side could be looking at a horizon of five years or even longer and asset managers could be looking at horizons from one month to a year or longer, adds Sheikh.
The buy side is also more interested in risk decomposition, or looking at the particular sources of risk within asset classes. While Value at Risk is an important measure of risk, investment managers are interested in more than just the number, says Sheikh. "At the end of the day what is important is to line up contributors to risk with contributors to return and Value at Risk doesn't tell you what was contributing to the risk, it's just indicating what the risk is."
Thijs Coenen, head of risk management at ABP Investments-the investment management arm of the ABP Pension Fund--which also recently installed the Barra TotalRisk system, agrees that risk decomposition is important for the buy side and especially larger firms such as ABP. "We needed a system that was able to decompose total risk or active risk relative to a benchmark according to various investment decisions," says Coenen.
Coenen also points out that data is an essential element in risk management systems, particularly on the buy-side. "Risk management is 70 percent data management, so we have to solve a lot of practical data management issues and Barra incorporates a huge database consisting of benchmarks for a large universe of securities," he explains. Sheikh adds that while a capital markets firm might only need data on the securities that they own and that influence those securities, buy-side firms have much broader data requirements.
"A typical asset management firm will need data cutting across many different asset classes, including structured products," says Sheikh. "They need data not just on what they own, but also what is in their benchmarks, what the benchmark constituents are and how those change over time." Data according to different risk dimensions such as style, sector and industry is also important, he adds. For example, a value manager would need data and risk models specific to that style while overall a risk manager would need to view how that style contributes to the overall risk and would need additional data for each of the areas or funds covered by the firm.
While data is nothing new in terms of risk management, the breadth and depth of the data necessary can be boggling for some firms. As a result, the outsourcing of data management-cleaning data, documenting data, updating data and setting up models-has become more popular. Sheikh says that data is something that "can and should be outsourced" to the extent that firms' requirements can be met. Peter Keppler, senior analyst at Meridien Research, agrees that outsourcing or application service provider (ASP) offerings will become more of the norm from data providers. Buy-side risk management analysis may be just another value-added service offered by data providers. Keppler adds that this type of outsourced offering is most popular with smaller to mid-size buy-side firms.
Sheikh emphasizes that there is a difference between large firms versus smaller firms and what their budgets and needs dictate in terms of a single system or multiple models and separate data sources. But for smaller firms and those not ready to venture down the sometimes overwhelming enterprise-wide risk management system path, technology is not the only factor for sound risk management. "There is a very large piece of risk management which is not system related," says Sheikh. "It's having the risk management culture and the risk management framework in place. A risk system only starts to make sense once you have that framework in place."
In any case, competition and risky markets have put risk management on the forefront in recent months and the trend toward buy-side risk only continues to increase. Sheikh sums up the drive toward risk management saying, "Risk management is part of business management and if you're in the fund management business, risk management is really business management and if you have sound business management practices you have to have sound risk management practices."