Meeting long-term portfolio investment objectives in an increasingly complex and dynamic global investment landscape is leading Australian asset owners to develop sophisticated multi-asset investment strategies.
Best positioning these investments for the future requires a comprehensive understanding of the portfolio. Additionally, from a regulatory standpoint, trustees are required to demonstrate a fit and proper framework for selecting and managing investments in a manner that is appropriate to the size, business mix and complexity of business operations.
To deal with these challenges, many are turning to third-party investment risk systems.
However, implementing a risk system is a comprehensive undertaking and it is easy to underestimate the resources, time and cost involved. It is also not easy for these systems to fulfil their ultimate objective: helping people to make forward-looking investment decisions.
Centring on this objective, Frontier has developed a framework for thinking about investment risk and risk systems. It is an integrated and structured way for an organisation to think about how risk is defined, measured, monitored and actioned. We refer to this framework as an Enterprise Risk Management Platform (ERMP).
Importantly, it advocates an approach to risk management that transcends the investment function and is consistent across an asset owner’s variety of business units. In this manner, they are able to achieve an efficient, effective and consistent flow of risk information from the various business units up to the executive and trustees.
This article encapsulates some of the key ideas and readers can access our full research on our website.
Why is it important?
Practically, an ERMP approach reveals that the selection and implementation of a risk system is about much more than the technical functionality of the risk system software. It is about how the system will fit into the broader investment governance framework to enhance investment decision making and meet regulatory requirements.
This requires detailed consideration of numerous aspects related to system implementation and operation. Selecting a risk system in isolation, without due consideration of these issues, makes it very difficult to achieve a smooth interaction between the risk outputs from the system and the investment decisions that need to be made. It is important to address these considerations up front.
While full detail on these considerations can be found in our research papers, here we cover a sample, being an organisation’s data requirements, IT and budget.
First, data is the most challenging aspect of any risk system. It is important to ask questions such as: What data is needed? Where is it going to come from? Who is going to load it in, and how long will it take? And how do we model complex securities? Australian institutions are relatively rare in that they have large and complex multi‑asset class portfolios with varied implementation methods. In contrast, risk systems have evolved out of modelling fixed income and equities. Accurately modelling assets such as alternative debt, private equity, property and infrastructure is challenging and at the extremes involves either a prohibitive amount of time and resources, or numerous simplifications and assumptions. The data decisions made at the start have a compounding impact on the resulting output. Poor (or poorly articulated) choices will generate spurious results, which ultimately engenders a lack of trust in the system. Deciding on how data will be managed and used is the single most important decision in selecting a risk system.
The data requirements for a risk system will also impact the required IT solution. This is an often overlooked aspect of system implementation. Using investment managers as a case study, all have comprehensive and well-integrated IT systems. This facilitates an efficient use of data and allows it to be an empowering input into the process as opposed to a burden. An organisation’s propensity to invest in supporting IT dictates the risk systems under consideration.
Finally, implementation of a risk system involves more expense than simply the outlay for the software. Investment is required in the people and systems to support it. This is an expensive but critical undertaking. While this can make many risk systems cost prohibitive, they simply will not work efficiently or effectively without it.
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An informed choice
Decision making is all about making an informed choice on the balance of information at your disposal. As Australian asset owners grow in sophistication and complexity, getting the right data to those who need it becomes increasingly complicated. A tailored, structured and flexible framework is required.
A risk system can be a powerful tool in this fight, but a significant investment of time is required up front to consider how your organisation will turn data into decision.