For companies with material investment portfolios, the market turmoil in the aftermath of the global financial crisis has magnified the importance of accurate and timely investment portfolio information. It has also helped make many of these portfolios more integral to the formal GRC and ERM programs.
According to Courty Gates, the CEO of Clearwater Analytics, there are four pillars to investment portfolio reporting and analytics: accounting, compliance, risk, and performance.
Together these areas comprise the mission-critical information required for portfolio monitoring and management, Gates adds. The importance of the information to an institutional investor varies directly with the size of the portfolio relative to the enterprise value; the larger the ratio, the greater the impact of the portfolio with regard to GRC and ERM.
I recently asked Gates to expand on some of these points in an e-mail chat ...
... And here's what we covered:
Eric Krell: What are the major risks (and/or new risks) involved in managing an investment portfolio?
Courty Gates: For an institutional investor at a high level, lack of transparency is the greatest risk and akin to flying an airplane without instrumentation. At the portfolio level, risk is measured across several dimensions of exposure, including country, currency, sector, security type, credit, duration, and issuer. Depending on market events, the relative importance of the dimensions ebbs and flows. Top of mind in the past few years have been security type (e.g., ABCP and ARS), sector (e.g., financial) and issuer (e.g., Lehman) concentrations. Many of our clients have adjusted their investment policies to reflect changes in their tolerance for risk. Monitoring compliance with the investment policy is integral to the portfolio manager's responsibilities.
Above all, portfolio managers need to be able perform analysis, answer questions, and make decisions based on accurate, current information. Ignorance is not bliss, particularly when risk exposure and investment results need to be reported up within the organization. From the perspective of the institutional investor, transparency across all portfolios into the dimensions of risk is vital. Accomplishing this is not trivial and involves aggregating holdings and security master information, normalizing and reconciling the results, and building tools to extract information.
How investment portfolio risk rolls up to GRC at the enterprise level is complex in part because contributors to risk can be correlated. There is significant debate on the best way to address these correlations on an enterprise level, but there is consensus that transparency into the components is step number one.
Eric Krell: Has the financial crisis fundamentally changed the way institutional investment portfolios are managed?
Courty Gates: The immediate impact was a flight to safety in the form of higher credit ratings and shorter durations. One of our clients referred to this as “battening down the hatches.” A series of headlines on security types and issuers combined with declines in asset values elevated the awareness of the portfolio's contribution to enterprise performance and risk and consequently increased the importance of the portfolio management function. I should add that the financial crisis is not the only touchstone for how and why investors have had to reevaluate the way they view their investment portfolios. Interest rates, unemployment rates, and changes in the yield curve have also contributed to increased focus on performance and risk across most enterprises.
Before the subprime meltdown, the failure of Lehman, and the ensuing crisis, many investors treated portfolio management as more of an operational function than an actual investment activity focused on opportunity and risk. Depending on the purpose of the investment portfolio, holdings can cover a broad spectrum of asset classes. For example, investors with heavy concentrations in long-duration, mortgaged-backed securities were affected very differently than those with short-duration portfolios. Independent of the type of exposure â€“ duration, credit, sector, issuer, etc. â€“ the need to quantify and explain it quickly has become critical.
For clients that have a handle on their exposures, we are starting to see the pendulum swing toward a more balanced approach to performance and risk, with more credit and duration exposure. One client said, “We are still in the lifeboat, but it is a larger lifeboat.”
Eric Krell: How are corporate treasuries addressing the risks associated with managing an institutional investment portfolio in the current environment (e.g., interest rates, regulatory reform, etc.)?
Courty Gates: Corporate treasuries are demanding transparency and are applying technology and outsourcing to accomplish that objective while optimizing the use of internal resources. Our clients and prospects frequently cite the limitations of manual processes, spreadsheets, and legacy systems as being among the key drivers behind adopting new solutions.
Investors frequently use a combination of installed point solutions and spreadsheets that are not "integrated-by-design," requiring layers of middleware, custom coding, and manual intervention that add cost and complexity and expose them to unnecessary risk.
For the investment management function, we strongly advocate daily, integrated accounting, compliance, performance, and risk reporting and analytics constructed on a foundation of aggregated and reconciled tax lots to monitor the investment portfolios, make informed decisions, and report to senior management.
Adopting new technologies, particularly software-as-a-service (SaaS), places minimal operational strain on IT departments, which do not have to upgrade hardware or install regular software updates. Outsourcing portfolio reporting and analytics places the burden on a third-party vendor with deep competence and allows investors to deploy internal resources in a manner that plays to their core strengths, including monitoring and responding to the portfolio risks.
It's also important to note that the demand for transparency and the need to address emerging accounting issues have stretched internal teams and legacy systems further and further from their original purpose. When these teams and systems are stretched beyond their limitations, it is only natural that some functionality falls through the cracks. In that regard, it is fair to say that technology and service providers that offer daily accounting, compliance, performance, and risk reporting and analytics will help investors deploy resources more effectively and make better decisions.
Eric Krell: Why should C-level executives become more focused on the performance of their investment portfolios?
Courty Gates: Companies focusing on risk at the enterprise level realize the importance of their institutional investment portfolios' role in generating income (although low today) and maintaining liquidity. The balance of risk and return is integral to the purpose of the portfolios.
Additionally, emerging accounting issues regularly change the regulatory reporting requirements. As a result, C-level executives need to be aware of the portfolio strategy -- including risk and performance -- and be confident that the investment and accounting results are being reported accurately. C-level executives should receive regular reports on key portfolio metrics and be able to get daily information as needed. ###