Peter Jones outlines the value-added S&P* fixed income securities evaluation services available to hedge fund managers and institutional investors.
HW: What does your division at S&P offer fund managers?
PJ: Our division, namely security evaluations, provides daily valuations on fixed income securities out of offices in New York and now in London too, where we have recently expanded the group.
Our daily coverage provides over 2.5 million evaluations on fixed income asset classes ranging from thinly traded corporate bonds to high yield, convertible bonds and floating rate notes, as well instruments such as US mortgage-backed and asset backed securities.
HW: What were the factors behind the launch of S&P's fixed income securities evaluation service?
PJ: The requirement for independent valuations in this area originally came from the US market, where the mutual fund industry has to provide daily NAVs, therefore US fixed income funds have to be marked to market.
In the US, they realised that the universe of fixed income securities was very large and that trades relative to this universe are very limited. So the business really grew out of the municipal market where bond sizes can be small and trading in issues illiquid.
Demand for the fixed income securities evaluation has grown steadily, driven by fund administrators, third party administrators, fund managers and software vendors who provide other services to funds requiring a source for illiquid pricing. It has now been established in the US for over 30 years.
There are a number of evaluation services in the US market, and as the European market sees greater allocation to fixed income, the demand for the service has grown. Requirements in Europe are being driven by regulatory pressure and the greater focus on the need for better risk and operational management across all asset classes and functions.
HW: Does the service extend to hedge funds?
PJ: Both mutual funds and hedge funds come to us to look for sources of pricing. Hedge funds and their administrators can use the service within their NAV process. It is available as a simple data feed to either the manager or the administrator, or both.
HW: Is it a stand-alone service?
PJ: We are agnostic as to how the service is delivered. It can be delivered on its own, or it can be packaged along with other information vendors depending on what managers require. It can be provided through a third party vendor or software platform. For example, we have recently announced a distribution agreement with Bloomberg for our US municipal universe.
HW: How is the fixed income securities evaluation service priced?
PJ: Fees are very important, because our service is aimed at institutions, the fees are typically based on a per security, per hit basis. What this means is that you might have some pension fund businesses who would value on a monthly or fortnightly basis, or other businesses that produce daily NAVs, and require our valuation to input into this process. We also see some institutions who just use the service for index tracking or risk management. Regardless of their varying frequencies of usage, clients only pay for what they use.
HW: How do you process the securities data underlying the service?
PJ: There are limited number of sources of data for terms and conditions, we choose different sources for different asset classes. We also take market price intelligence, from the buy- and sell-side as well as other sources such as data feeds. We then apply front office valuation methodologies to this data using credit spreads over industry sectors and over issuer curves. We have groups of professional evaluation staff, based in New York and London that monitor issuers, issues and information flows on a daily basis. The teams review liquid sectors and liquid traded bonds vs. illiquid sectors.
HW: What value is there in using a service like yours?
PJ: Our service is a premium service. The evaluations are not an aggregation of price feeds, and they are our opinion of value. When we talk to the front office about our methodologies they are comfortable with the processes used in terms of the quality of our methodologies. It is also important that our processes are independent and transparent, as part of the service provided requires interaction with fund managers, administrators, pricing analysts and market participants. Users can call us up and speak to the evaluation staff to verify how a specific instrument has been valued and our staff are knowledgeable market professionals who can talk the client through the valuation and valuation process.
HW: How is the service being rolled out in Europe?
PJ: The service was launched in Europe in 2002, based on an exclusive distribution agreement with Telekurs. We now have around 60 institutions who are using the service for the purpose of administration and production of NAVs.
The original offering covered 30-40,000 European instruments only but we are now able to deliver our US evaluations and the European content set direct to the market.
Any global hedge fund business, based in any global location, can now access the full service covering 2.5 million fixed income securities evaluations.
HW: What feedback have you had so far in Europe?
PJ: The feedback tends to focus on issues such as 'hard to price' vs 'complex' instruments to price.
To my mind, an instrument that is hard to price does not necessarily mean that it is a difficult instrument to value. The problem comes in trying to put in place a daily operational process for valuing that security, in essence trying to institutionalise the pricing of that security in a cost-efficient and robust manner. The front office can price these securities, but we can institutionalise the process of valuation. We can provide a cost efficient and importantly independent daily valuation that can aid the transparency of their operational processes.
When you have complex instruments such as US mortgage-backed securities or CDOs which have underlying collateral, these become more complex to value, but here again, we help managers and administrators in providing independent valuations. We are currently working on projects to provide daily valuations on European products of this nature.
HW: Is there scope for the securities evaluation service to be offered via third parties such as prime brokers to their hedge fund clients?
PJ: Over the last year, we have seen the need in the area of complex and illiquid instruments for bilateral or even trilateral valuations for transactions, so there is scope to incorporate our service into these institutions as a white labelled service. The use of our service may help some institutions in reducing the inherent conflicts of interest in counter party valuations.
The increasing requirement for transparency in the hedge fund arena is also a major driver towards the use of independent valuations. While some managers may be uncomfortable about transparency, we look to produce a level of comfort among all our clients in terms of the process and procedures and this approach extends to hedge funds too.
HW: What is your message to European hedge fund managers and their service providers?
PJ: The message is that S&P's evaluation service is a credible, independent service for daily valuations on over 2.5 million fixed income securities. It is already available to the market and helps to provide an extra level of independence and transparency within the administrative functions of the funds. The value added service takes into account daily market moves and trade intelligence.
* Securities evaluations services are provided by Standard & Poor's Securities Evaluations, Inc., a wholly owned subsidiary of The McGraw-Hill Companies, Inc. Analytic services and products provided by Standard & Poor's are the result of separate activities designed to preserve the independence and objectivity of each analytic process. Standard & Poor's has established policies and procedures to maintain the confidentiality of non-public information received during each analytic process.
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