Managers of U.S mutual funds, separately managed accounts and other asset pools are pretty concerned about whether they calculate their risk exposure and performance results correctly and report correctly to regulators and clients.

Those areas are also where likely to spend most of their operating budgets over the next year, according to the first-ever survey of fund managers just completed by Money Management Executive. Why? They are either not automated or “somewhat automated.”

That’s not exactly an ideal scenario for asset managers that can’t afford to make any operational errors. They must know just what is causing them to process a wrong payment, fail to settle a trade on time, miscalculate the value of their assets or send incorrect reports to investors and regulators. Also critical: understanding the potential for financial loss based on the types and values of financial instruments the fund manager trades and the strategies used.


Whether or not they accurately measured their risk topped the list of worries for fund managers at 72% of the 261 respondents to the survey distributed by Lodestar Research. Next up: how well they calculated their performance—at 68%. Sixty six percent of respondents were concerned about how well they managed client reporting, while 60% worried about financial reporting. Whether or not new customer accounts were opened correctly didn’t fall too far behind. Fifty nine percent of the respondents said they were concerned.

The category of operational functions giving fund managers the most angst matched up well with the level of automation in each functional area and where firms will spend the most money to improve over the next year. Smaller sized managers, those with under $500 million in assets, appeared to be far more concerned about accuracy and the potential for error. And rightly so. They are the least automated. As a result, they also scored higher than far their larger peers in anticipating their firms would spend more on technology in the same categories.

About 28% of respondents said that their measurement of risk was somewhat automated, and 12% said it was not automated at all. In the case of performance metrics, 26% of respondents said that they were somewhat automated. About 30% of respondents said they were somewhat automated when it came to valuation and financial reporting, while 31% said their client reporting is automated. Customer onboarding scored the highest levels for either not automated or not very automated—at a whopping 31%.

Just what does “somewhat automated” mean? Most likely a combination of completely electronic procedures and some manual intervention—aka calculations on an Excel spreadsheet.

So where are fund managers likely to spend money? Client reporting scored the highest. Thirty two percent of respondents believe they will invest in new technology to shore up their statements to clients, while 27% think they have to do so for risk management. Financial reporting followed at 26%, while valuations came in at 18%. Twenty one percent of respondents said they expected their firms to spend on automating the procedures for onboarding new customers.

“The priority is for these firms to ensure that their information is both accurate and transparent. You can expect to see firms continue to go the way of automation in an effort to meet both ever-changing regulatory requirements and the needs of clients and shareholders,” said Steve Lipof, practice leader for the compliance and regulatory unit of AlaS Consulting, a New York based financial services consultancy.

Not only do regulators want as much information as possible about fund managers’ performance but so do investors. They need to understand how well the overall portfolio is doing relative to industry benchmarks, where the highest returns are being made and how much risk the fund manager is taking. That risk reflects the probability of financial loss to a percentage of the portfolio due to market fluctuations or the default of a particular counterparty.

Investors also want data at their fingertips—on desktops and even mobile phones. End-of-day or next-day reports just won’t cut it anymore.

Yet despite their concern about accurate risk calculations, performance metrics and reporting, spending money on one overriding requirement—data—didn’t make the highest category. About 20% of respondents said they expect their firms will automate their processing of corporate actions such as income payments, tender and exchange offers, while 17% said they would do so for updating reference data—descriptive information on securities. Fourteen percent of respondents believe their firms will be spending more to automate their acquisition and distribution of counterparty data—information identifying their trading partners and customers.

That stance doesn’t seem to jive with what industry consultants insist is a heightened awareness of the need for efficient data acquisition, normalization and distribution. Fund managers, they say, are working on either licensing or developing some incarnation of a data warehouse which will not only store data, but also aggregate it quickly from multiple applications as quickly as possible. Asset managers will need to have that data readily available in case investors or regulators ask them to validate their calculations and decisions.

So why the discrepancy? Respondents to Money Management Executive’s survey didn’t know much about whether their current level of automation when it came to the data they were using. That’s not surprising considering that many middle- and back-office operations executives actually consuming the data don’t often pay attention to how their firm is managing data unless they either can’t find it quickly enough or a costly error has been made. That’s often the case with corporate action events. Thirty five percent said they didn’t know how automated their firm was in maintaining counterparty data, while 32% said they didn’t know for reference data, and 27% didn’t know for corporate actions.

Concerns over making errors in collateral management and clearing of swap contracts also weren’t that high, considering all the regulatory attention on automated trading and centralized clearing. Only 29% said they were concerned when it came to collateral management and 28% for clearing.

“Fund managers we service are spending more attention to processing issues related to swaps so the responses were surprising,” said David Kubersky, managing director in North America for SimCorp, an investment management technology firm in New York.

One possible reason for the potential lack of interest: a pretty high percentage of respondents didn’t have a clue on their firm’s level of automation in the swaps arena—close to 38%. It was the highest percentage of “don’t know” responses in the category of the level of automation.

Another likely reason: too many of the rules concerning how over-the-counter derivatives are to be traded and processed are still being worked out by the Securities and Exchange Commission and Commodity Futures Trading Commission, so asset managers are taking a wait-and-see approach. But that lackadaisical stance might not last for long, according to legal experts.  The SEC now says that it now wants mutual funds to disclose a lot more about their activities in the swap market.

As is often the case, regulatory burdens ended up being pretty high on the list of why fund managers will spend any money on eliminating manual work. About 64% of the respondents cited legislation, while 38% cited investor demands. Thirty percent said adding new financial instruments to their investment mix was the motivating factor.

The two regulations with the highest scores: the Dodd Frank Wall Street Reform Act and the Internal Revenue Service’s cost-basis-reporting rules. The SEC and other regulators want fund managers to keep better track of what they are trading, when, with whom and how much. The IRS, in turn, wants mutual funds as of 2012 to calculate the exact cost of the accounts of their investors. That’s more than just a number-crunching exercise on a tax accounting platform. Asset managers must also ensure that any customer-interfacing applications and statements show not only the correct cost-basis calculations but the options the customer has in deciding which methodology to use. And they must allow the customer to select that option and change his or her mind.

Winning 34% of respondent votes, cost reductions trailed investor demands as a reason for innovation. That is even though they want to ensure they can process all the new financial instruments they want to trade. One answer: rely on multi-asset class platforms or even outsource the function, Kubersky said.

Forget about adding new staff over the next 12 to 18 months. The possibility of that being either likely or highly likely was 8% at most. And that was in the category of regulatory reporting where the need to eliminate reputational risk and financial penalties outweigh budgetary constraints.

When it came to whether new IT platforms would be home grown or licensed, fund managers were evenly divided. About 23% said they would rely on a proprietary system, while 21% said they would license them. About 17% said they would rely on a combination of the two, while 7% said they would completely outsource a service. Twelve percent said they expected to use a hosted platform—which technologists always tout as a far more cost-effective means of benefiting from new operating systems. It reduces the number of staffers who have to manage applications.

Who makes the ultimate decision on what operational changes need to be made? Business line operations executives trumped IT managers. About 45% said that operations executives would be leading any project to improve operational efficiency, while 29 percent said IT managers would.

Mitigating the potential for errors and making the necessary technological investments takes far more than planning than acting on gut instinct. Fund managers need some way of quantifying the number of errors, where they have occurred, how much they cost and the likelihood they could occur again. Asking senior management to pay for new technology isn’t easy unless there is a hard dollars-and-cents return on the investment. Using the fear of regulatory intervention isn’t the only way.

Fund managers are starting to wise up on the need to measure operational risk—or the potential for financial loss from errors—on a departmental and even enterprise level.  About 18% of the respondents said their firms will improve measuring operational risk on a unit basis, but 61% said their firms will do so on an enterprise-wide basis. That’s in tune with what regulators say they want to know so they can mitigate systemic risk.

Even better: 51% of respondents say they use a combination of qualitative and quantitative means to measure operational risk. Qualitative measures include reviews of their procedures and how they lived up to company expectations, while quantitative measures include key risk indicators.

“Fund managers are becoming more sophisticated in how they are measuring operational risk, but they are still relying heavily on a historical perspective of event losses,” said Edward Hawthorne, a partner at global financial services consultancy Capco in New York. “The ultimate goal would be to complement this with improved intraday visibility of key risk indicators that management can act upon to better prevent future losses.”

At the very least, fund managers are taking notice of the need for specialists. Historically, the task of managing operational risk was designated as an “add-on” function to either the operational director of a particular business unit at best or a credit or investment risk specialist at worst who had little, if any, understanding of the topic. But 49% of respondents said that their firms had a chief operational risk officer or C-level executive specializing in operational risk.

-- This article first appeared on Securities Technology Monitor.


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