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Increased Demand for Risk Analytics from Buy Side, Finds Northern Trust Survey

The institutional investor and investment management community is keen for more data and analytics around risk management, according to a recent survey by global custodian Northern Trust. Not only is risk a prime area of investment for banks, the buy side is also being forced to re-evaluate its approach to risk modelling and analytics.

The survey, which involved responses from 50 global investment managers earlier this year, indicates that these buy side firms understand the need to improve their organisations’ ability to successfully implement risk models in the investment process. More than half of the survey respondents were from institutions or managers with over US$1 billion in assets under management, and 20% had more than US$5 billion under management.

The majority of respondents to the survey, at 90%, indicated that they rate risk as an “important” or “primary” consideration in their decision making. However, roughly the same percentage feel they need additional skills and experience to effectively model, interpret and utilise the results from sophisticated risk models. This supports the findings of the recent barrage of risk management related reports from the consultancy sector, all of which indicate risk management is a key area of focus for 2009.

The risk profiles of these institutions have also changed as a result of the market conditions, according to survey respondents, especially with regards to portfolio risk. Liquidity risk is certainly at the forefront of the minds of bankers in the UK as a result of the Financial Services Authority’s incoming liquidity reporting regime and it seems that the buy side is also taking notice. While market volatility remains the greatest source of risk, liquidity risk emerged as a leading concern following last year’s credit market crisis. A total of 17% of respondents felt liquidity was the greatest source of risk for investment programmes in 2009, compared to just 2% who thought that was the case in early 2008.

Much the same as the sell side, the buy side is looking at the area of valuation and related risk models: 45% of the respondents said valuation and risk models could have performed better in predicting the impact of liquidity risk over the last 12 months. This supports the recent surge in activity within the vendor community with regards to valuations offerings aimed at providing greater transparency and more data around a price.

“Institutional investors and investment managers are telling us they want valuation model transparency and they appreciate practical experience in using risk models,” says Paul d’Ouville, head of Northern Trust’s C & IS Global Product Management Group. “There is a new reality in the security pricing arena, where complexity has increased and transparency is expected. With their resource challenges, organisations are increasingly seeking expertise from outside firms that can demonstrate practical solutions and help them benefit from the information provided by quantitative risk models.”

It seems that although the buy side understands the importance of risk management, they have largely not yet invested in IT systems to support the function. According to the survey results, 93% of respondents said they generally believe risk models provide useful information but 55% do not currently have a risk measurement system in place. This is yet further proof that the risk management vendor community is in for a bumper 2009, well, in comparison to the rest of the financial technology sector that is.

As well as IT issues, staffing is also a key problem for these organisations: 87% of respondents indicated they feel their organisations need additional skills and experience to effectively model, interpret and utilise the results from sophisticated risk models. Moreover, when it comes to purchasing a risk measurement system, around 40% said the level of experience on staff to manage the system would be an inhibitor.

This implies that the vendor and third party services community should therefore adopt a hand holding attitude towards the buy side with regards to risk management systems implementation. By providing guidance and support and making it as easy as possible to understand the impact and functionality of these systems, as well as providing an interface that is as intuitive as possible, it is likely that they will gain more traction in the market.

Survey respondents highlighted a key area of focus for the next year within the risk sphere: 51% said their organisations needed to improve their efforts regarding due diligence on the valuation process for their portfolios. This, yet again, proves the primary importance of pricing data in the current market environment.

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