Portfolio Accounting Systems:

Hedge Funds Turning to Multi-Asset Class Systems To Meet Clients’ Need for New Investment Products

Originally published June 23, 2008

NEW YORK — A growing number of investment managers and hedge funds report they are on the lookout for multi-asset-class portfolio management and accounting systems that can offer “deep” accounting capabilities as a core functionality. The need for new software, the asset managers say, is being driven by rising customer demands for enhanced investment products, including alternative investments, and increasing use of advanced, often proprietary, trading or arbitrage strategies driven by the quest for alpha. The hedge fund boom in asset growth is one of the biggest money management stories in this decade, says Denise Valentine, Senior Analyst at consultancy Aite Group. “Derivatives processing is one of the most important [systems] enhancements,” she adds.

Another software category that has growing appeal for hedge funds and buy-side institutions includes wares from crossover vendors whose products have sell-side origins. Many of these tools deliver risk analytics and valuation modeling capabilities. These technologies are often viewed as front- and middle-office systems, but the functionalities they offer are migrating upstream in the value chain.

“They are in high demand with the portfolio managers who are trading the instruments and working at the valuation models, trying to understanding ‘what-ifs,’” says Valentine. Some hedge funds and traditional firms use both types of systems.

Additionally, vendors with accounting systems used by the traditional, long-only money managers have also set sights on the hedge fund community. “There are plenty of firms that market or try to market to hedge funds, but that does not mean they are big players in the field,” notes Valentine. As firms continue to enhance OTC derivatives processing capabilities, they also deepen their product’s accounting capabilities, she adds.

Portfolio systems providers are also enhancing software to give managers the tools to comply with FASB 157 fair-value measurement guidelines and the ability to do derivatives valuations. To be sure, many major institutional managers are starting to look more like hedge funds or have books of business that resemble them. Investment firms such as Barclays Global Investors or university assets managers like Harvard Management Company are often dubbed “the biggest hedge fund” by some, a term now used loosely also to describe sell-side players such as Goldman Sachs.

For years, institutional managers tried to get by with systems not really designed to handle derivatives. They would build systems to account for both derivatives and traditional instruments, but they could not produce consolidated reports of positions or exposures.

Today, even international traders seeking to follow a plain-vanilla, traditional course need to trade swaps and other instruments for tax and market reasons. Without capturing the underlying details of swaps and other derivatives transactions, it is very difficult to track positions and exposures for risk management or to give clients accurate, financial reports. When accounting systems treat derivatives as zero-coupon bonds, a lot of the information needed to accurately assess risk and monitor cash flows is lost. These trends make legacy accounting systems a liability.

Firms with legacy systems where transactions are entered as single-lot records are effectively skipping multi-basis accounting and doing reports “on the fly,” observes Pamela Pecs Cytron, President and Chief Executive Officer of investment accounting software provider Pendo Systems, which offers BasisPoint, a multi-currency, multi-basis and multi-client accounting system. As a result, transaction information is not fundamentally stored in the database, presenting an increasing problem for such firms, according to Cytron. “When we bring a transaction into BasisPoint, we take that transaction and depending on whether an asset manager needs the information, we break it out at the lot level by basis and store all that information in the database,” she says.

BasisPoint breaks down and collapses silos, adds Cytron. A firm running four accounting engines may send a report on the same asset that is running in all four accounts, but they result in different numbers, she says. “What everyone has discovered is that reference data and data warehousing are not the answer, because all those do is take computed data sets of the old data and put them in one place,” says Cytron. “But that doesn’t fix the problem that the numbers are still different.”

In addition, BasisPoint offers a cancel-and-correct process called “Cancel and Re-book.” If a client discovers an error in how a security was set up after months into an accounting period, they would have to manually unwind all the transactions and rebook them, which can cause a high degree of error, notes Cytron. BasisPoint automates this to reduce the errors.

Performance analytics is another area where asset managers and hedge funds say they are seeking better capabilities. Clients, they say, are demanding better understanding of how changes in the portfolio impact risk. As desktop computing power continues to increase, portfolio and accounting systems vendors are under pressure to incorporate advanced capabilities into their software. In a market seeing a lot of fluctuation in pricing and valuations, back offices are concerned about accounting for new instruments, says Kenneth Petersen, Senior Vice President and Head of Sales, North America, at SimCorp, a Copenhagen-based investment management systems provider that plans to heighten its US profile. SimCorp released version 4.3 of its Dimension system in April. “We incorporated a modeling language, ExpressInstruments, into Dimension, which means you can actually model these new instruments in SimCorp Dimension in a few days,” says Petersen. “It might take three to 12 months before other systems could incorporate a new instrument.”

It is not unusual for the front office to announce they have a new instrument to trade as part of an alpha-capture strategy, leaving the operations staff to figure out how to account for it in existing systems. Some large buy-side firms have many back-office systems, because they have bought or merged smaller firms or funds. They turn to SimCorp Dimension as one system where their management can see their total exposure and risk, explains Petersen. Dimension is a front-to-back system including trade order management, pre- and post-trade compliance, performance and accounting, including net asset value calculations for mutual funds and client reporting.

Schroders, the global asset manager with £139.1 billion (about $276.8 billion) under management at year-end 2007, went live in April with the first phase of a complex, three-year project to move to SimCorp Dimension, which will act as Schroders’ portfolio book of record for its UK and US operations that are based in London. Schroders selected SimCorp Dimension because it provides the best all around fit for functional needs of the money management firm’s business and strong support for derivative instruments, according to Matthew Oakeley, Head of Group IT at Schroders.

Even as they seek to enhance portfolio accounting support, some institutional investors remain wary of changing systems. “No canned application will be sufficient out of the box,” says Jenny Tsouvalis, Vice President, Investment Operations and Applications, OMERS Administration Corporation, with C$50 billion in assets under management. “We use a data-centric model. If systems have enough user-defined fields, as long as we can populate the data elements and link to various records, we can develop extensive reporting as an add-on to the systems with the data residing within. “Many portfolio management systems are legacy based, but they’re tried and true, and they work,” continues Tsouvalis, who is also Chair of the Buy Side Committee of the Canadian Capital Markets Association (CCMA). “The biggest challenge in portfolio management systems is that they need to become more robust, not so much for bonds and equities — those are fairly established in the industry — but on the derivatives side, where the industry’s work probably resides at this point.”

Thomson Reuters has been adding functionality supporting hedge fund needs into its portfolio management and accounting solution, PORTIA, according to Christen Bremner, Managing Director. Users’ interest in trading non-standard asset classes such as derivatives has increased, raising demand among both North American and global users for systems that can process such instruments, adds Bremner. “They all want to add capability to support swaps and derivatives,” she says.

PORTIA has added capabilities to manage hedged positions and better understand hedging strategies. Its processing workflows are distinct for swaps and structured products, including loans, syndicated loans and derivatives, whether the data comes through interfaces or is entered manually, says Bremner. PORTIA has about 300 clients from 62 markets worldwide, some being large global firms and others boutique, fixed-income specialty shops, she adds.



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