Portfolio Science president Ittai Korin (pictured) says the firm’s provision of risk management services through an application programming interface is bringing risk tools to a broader range of investment industry players than ever, at a time when managers are realising that a seat-of-the pants approach to risk management and reporting is no longer adequate for their business needs or acceptable to their own clients.
GFM: How have attitudes to risk in the investment industry changed as a result of the crisis?
IK: Until recently many service providers had no interest or even understanding of the fact they needed to be in the risk reporting business. Over the past year, thanks to the knock-on effects of the financial crisis, everyone in the hedge fund food chain from investors to fund managers as well as prime brokers and other counterparties have realised that risk management is important and that they all need some sort of methodology in place.
The service providers that we work with may not have been in the risk business in the past but now they need to be able to offer these kinds of functionalities. We are very well positioned to help companies like that because we offer an application programming interface (API), a service-driven capability that’s designed from the outset to be private-labelled and wrapped within another application.
Our approach is contrast to that of other providers that offer a branded risk application with a user interface featuring their logo on it. These applications are presented the way they decide they should be presented, with their proprietary look and feel. The idea is direct sales to as much of the market as possible.
Our philosophy instead is to provide a completely flexible, extensible, customisable tool set that an individual fund manager or a service provider can simply connect to through their back-end systems and then utilise the functionalities completely within their own systems or application, white-labelled, tightly embedded and seamlessly joined.
To do this, you have to change a bit your priorities as a vendor. You have to not care about having your logo out there, about the traditional concepts of the brand or the look and feel of the front end. We’ve succeeded because we have concluded that what matters is being the back-end infrastructural DNA behind the risk services that service providers to hedge funds understand they need to offer.
GFM How do you deliver your service?
IK: Rather than through a stand-alone desktop application or a web site, we deliver it through an API that allows users to access risk exposure calculations through standard operating environments. APIs normally allow users to customise software by developing code that can access and manipulate the software’s features. Portfolio Science’s RiskAPI takes the concept further by using a standardised interface to connect securely over the internet to a risk engine running on our servers.
It simply consists of a software API that has within it a collection of individual risk calculations to which you add parameters. The API communicates those parameters securely over the network to our engine, which runs them through all its resources and delivers the result. At no point in the chain is there a front-end interface.
GFM: How do fund administrators offer risk services to their own clients?
IK: Fund administrators take position and trade data on a daily basis and compile reports including trade positions, NAV and P&L. The administrator will be running some kind of reporting framework, and it’s within that application that they drop in our API. They feed in the position data to determine metrics such as value at risk and correlation, the results come back from us on the fly, and they can disseminate them to their hedge fund clients through their existing reports, a secure web site or e-mail.
This saves the service provider a huge amount of time and effort. Even for the simplest asset class, for instance local equities, they would otherwise have to build and manage a database of historical data and deal with splits, capital adjustments and all kinds of corporate action. Just maintaining that database of historical pricing would be a significant challenge for a fund administrator to undertake. On top of that they would need a full understanding of the mathematics that goes into the risk engine. You’re talking about a massive divergence from their core business.
Instead, RiskAPI enables them to deliver a whole structure of results without really having to do anything bar a small amount of initial input. All they have to decide is what calculations they want and how they want to present them. We make it very affordable and speedy to go from the position data to the risk calculations they want.
GFM: Can’t your competitors offer the same service?
IK: Some of our competitors are quite large, but their business is based on brand. They will not let a fund administrator or prime broker offer their service under the provider’s own aegis, not because they can’t but because from a business perspective they’re not willing to do so. They prioritise the value of their own brand.
Two things make possible for us to do what we do. First, we have built the technology from the ground as an accessible service you can plug in under the hood, and secondly, we are happy to for our service to be embedded and hidden in the background.
GFM: How has the market developed as some of the dust has settled on the events of last year?
IK: There are changes in behaviour on three levels. First, the least technical, has come about because of things like the Madoff scandal and the consequences of the secondary and tertiary results of the crisis. Where the investor or prime broker had exposure to a fund holding financial instruments that were directly affected by the crisis, the loss experienced was a direct result of that. It’s pretty clear why those people want risk management now.
The secondary result affected funds that didn’t invest directly in any of those troubled assets, but did not have systems to tell them that they were exposed to these types of situation nevertheless, because of the knock-on effects upon the assets they did hold, such as financial stocks. The tertiary level was where the prices of funds that were invested in completely unrelated assets started falling not because they were affected by the sub-prime crisis but because investors were dumping assets in search of liquidity.
From direct exposure to the crisis to secondary, tertiary and even more distant relationships, players in the market are recognising the need for infrastructure that will at least warn them about these relationships, not least because having the fund manager tell them the assets are unrelated is no longer enough for investors.
GFM: How are hedge fund managers responding to this situation?
IK: It’s not that fund managers are waking up one morning and deciding they will buy a certain risk product. It’s more that all the things that used to work aren’t working any more as managers face things they never had to deal with in their entire career as an asset manager. They need some kind of quantitative tool to help them identify those things.
Rather than having a fine-resolution understanding of the four or five nuances between different approaches to risk, most are just waking up to the need for some sort of infrastructure. Some early adopters may just need to fine-tune their risk systems, but the vast majority of end-users on the buy side never even knew they needed or ever initiated a search for this kind of capability.
So typically the first place they will turn is the service providers that already provide them with reporting. That’s where we come in, because in addition to our direct sales effort, the service providers themselves are examining how they can offer these services that their manager clients are asking for. There’s a short list of things they can do to answer that question, and we’re on it.
GFM: Do you only deal with service providers that work directly with hedge funds?
IK: No, we have also reached agreement with a company called PortfolioShop, which rather than being a fund administrator or prime broker is a software vendor that provides reporting infrastructure to those service providers.
Today in the fund administration and prime brokerage market there are three types of player. The first offers a very rudimentary, lo-tech minimum level of service. The second is more advanced and offers good reporting capabilities by purchasing or building systems that are running in-house. The third type, which PortfolioShop services, doesn’t have any reporting infrastructure of its own but buys it in as a service or an in-house product.
PortfolioShop’s decision to offer risk reporting to its service provider clients represents a new strategy that reflects how the industry has changed. The firm, in particular, is really on the ground floor when it comes to hearing what service providers need and want.
PortfolioShop can now offer a whole suite of risk reporting tools to fund administrators and prime brokers in addition to the original features in its application. Thanks to this single integration, all of their fund administrator and prime broker clients can offer risk reporting to their own fund clients in turn. A significant portion of the market will benefit from this added capability.