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How to Make Risk a Competitive Advantage
By Rob Garfield | January 27, 2016

Many financial institutions once viewed risk management systems as necessary primarily for compliance purposes. However, today, a growing number of asset managers regard these systems as pivotal to the investment process itself—that is key to generating higher returns, limiting losses, improving margins and raising the confidence of clients, investors and stakeholders.

So, you may be asking, what has changed? Well, for one thing, technology — which was once a major obstacle blocking risk management from reaching its full potential — has broken through. Where older risk systems traded speed for accuracy, newer platforms use more sophisticated techniques such as algorithmic differentiation (AD) to shatter speed barriers. In fact, a number of top-performing investment firms are abandoning the traditional finite difference method (a.k.a “bumping”) for calculating risk sensitivities, and instead adopting AD. The outcome for many has been acceleration in portfolio risk calculations of 100-1000 times faster than bumping.

Several of today’s more innovative systems also offer access to risk analytics that not only help you monitor performance, but truly drive it. This is done through the use of intra-day metrics that cover everything from vanilla instruments through to complex structured products and hybrids. Leading firms are now using these systems to analyze their full spectrum of investments —both intra-day and on-demand. Furthermore, when risk analytics are incorporated into regular trade-decision workflows, the rewards include better trading decisions, better returns, and optimized capital deployment.

To attain these benefits, today’s top risk systems need to have these five characteristics:

  1. Fast: Risk platforms should offer the necessary speed, helping you move risk calculations from an end of day practice to intra-day and pre-trade. Having access to timely information will enable improved trading decisions.
  2. Accurate: Bumping is an approximate risk management technique. However, analytics platforms that leverage AD instill greater accuracy into risk calculations. The result is improved asset and liability matching, and more efficient use of capital.
  3. Flexible: An investment firm’s trading strategy can be an integral competitive differentiator. But the “one size fits all” approach used by older risk systems lacks the flexibility needed to accommodate different trading styles, and the rapid adjustments demanded by today’s dynamic markets. For these reasons, financial institutions need an enterprise valuation and risk platform that can accelerate the creation and valuation of nearly every kind of investment, including vanilla, exotic hybrids, and structured products. This approach can help them profit from investment opportunities that were once out of reach.
  4. Transparent: Increasingly, investors, shareholders and regulators are demanding greater transparency from financial institutions. As a consequence, firms are looking to adopt analytics platforms that offer full documentation for all models and an audit trail for all model changes. In today’s best-of-breed risk systems, models are documented in detail, with citations that reach deep into original sources.
  5. Holistic: In today’s market environment, investment firms need consolidated insight into their holdings. By normalizing models and assumptions, leading risk systems create arbitrage-free, holistic views of risk across the enterprise. These systems also foster consistency and faster time-to market, which inspire confidence in analysts, portfolio managers and traders. Each comes to trust the advantages of working collaboratively, using consistent data, assumptions, and models.

Firms that focus on these five pillars will be empowered to deliver superior returns compared to those that do not, and will ensure their strategies keep pace with their opportunities. While once this level of powerful risk platform may have only been accessible to large-sized firms with vast resources, today this is changing. There are more affordable, yet equally as robust options available in the marketplace.

If you are considering new risk technology, keep in mind that alongside these five pillars, systems built on a “future-proof” architecture will help you be highly adaptive to change. In the current environment of persistent risk and instability, having the ability to rapidly respond to change plays a key part in securing a competitive edge.

For more information on how advanced valuation and risk can help you drive performance, download our white paper: Creating Competitive Advantage with Risk Management: The Five Pillars