What’s the benefit?

Putting performance and attribution into context

People form habits and after a while they tend to lose focus on why they do things. They do them because they do them. Asset managers do performance measurement so they buy performance measurement. That all makes sense surely?

Well no, not really. For example, people don’t want mortgages, but they do want a home, the benefit of the mortgage is that you can buy your home now. Similarly, asset managers don’t want performance measurement; they want investors to give them money so they can earn fees and grow rich. Performance measurement is all about winning clients and then keeping them sweet.

Now you might say, that is completely obvious, so what? But in fact, thinking about it that way shows two things: 1. that performance measurement is essential if you want to run an asset management business and 2. That in an ideal world it should cost you as little as possible to do. It only exists because of the need to sell to and keep clients; it is not in itself an activity that is profitable for an asset manager. However, it is often viewed as a mysterious and dark art that requires extremely complex procedures to make it all work and, as a result, enormous resources are piled into it at some asset managers with no obvious benefit or improved result.

Indeed, in StatPro’s experience (and this covers not just the 230 clients we have won but also the several hundred we nearly won) there sometimes seems to be a baffling desire to over-complicate what should be straightforward. There are of course plenty of examples of asset managers that are extremely efficient and we can learn from them. At a time of economic turmoil, it makes sense to re-evaluate what is really required of performance measurement and how best to deploy it so that asset managers can minimise its cost whilst maximising the benefits.

Back in the 80’s the leading performance company was WM. They offered a great service where they centralised the portfolio information of most UK pension funds and calculated the performance of each portfolio once a quarter. This centralised service on a per portfolio basis meant that the price for this was not high for the pension funds. Because they measured over 2,000 portfolios they also had a valuable database which became a peer group that they could use to compare the performance of different fund managers. The service lost ground because the data frequency was not sufficient or detailed enough and asset managers decided they needed to get better information which WM could not provide them.

This meant that in the mid 90’s a number of performance and attribution systems started to appear. The first was Frank Russell’s RPA which proved very successful, but again failed to keep up with the development of the markets and so has withered significantly. FMC was an early provider with Sylvan a much more sophisticated system that became very popular. StatPro appeared on the scene in 2000 with our own offering we called SPA (StatPro Performance & Attribution). Between then and now, 30 or so companies have produced similar systems with varying degrees of success.

One consequence of all this competition has been for industry specialists in and out of asset managers to focus on the level of functionality of these systems and not question why they are needed in the first place. The early systems were simpler applications which had their databases in silos. The later ones have developed sophisticated data warehouses to handle the increasingly large demands for data management. But why is it necessary to go to such lengths to gather and manage such huge volumes of similar data at each asset manager? We all need electricity but we don’t build generators and nowadays if we don’t like our electricity supplier we can switch to a different one. It is time to re-think the way an asset manager accesses performance measurement.

For a start, how about asking the supplier to manage the IT platform? The last thing an asset manager needs is more servers and all the hassle of managing them. Secondly, all the data for indices can be managed by the supplier as well. Why should the asset manager have to unravel the complexities of the MSCI, FTSE, Russell, Lehman, Stoxx, Ibox, Euronext, DAX, Nikkei, JP Morgan, S&P and all the other indices? Much better to tick a box to choose which one you want and let someone else sort it out.

The third thing is slightly more complex but absolutely crucial. Amongst performance professionals there is consensus that Transaction Based Performance is much superior to Holdings Based Performance as of course it takes into account the trades that are made by the manager at the transaction price rather than the end of day price. However, the improved accuracy comes at a cost in terms of extra data required and the size of team needed to manage the vast data flows and it may be sensible for asset managers to consider whether that cost is worth it.

I wonder how many people in the industry stop and ask “Is transaction based performance actually accurate?” If they did they would surely say “No, it is not accurate, but it is a better approximation.” It is only an approximation because for each investor their circumstances are different. They invest with the asset manager at different times and sell at different times. They have varying tax bills depending on their total income and domicile. The tax rules themselves vary over time and domicile. The valuations used to provide the daily valuations are snapshots from a market feed, usually end of day but possibly any time and in any case, if someone tried to liquidate the entire portfolio at once, they would surely not get the same prices. On top of that, conventions like the re-investment of dividends to show total performance are artificial. The result is that even if the portfolio has a single owner the performance is still approximate.

So if it is just an approximation why do it? Well the answer to that is that asset managers need to give a true view of their money management skills. The investor has to accept that his personal performance depends on him (calculated between when he puts the money in and when he takes it out), while his money is in, he will get a report that uses conventions like Year to Date performance, 1, 3, 6, 12 month performance and so on. The idea is to make comparisons between asset managers possible, but depending on the nature of the investor, it maybe that Holdings Based Performance is perfectly adequate for their needs. If that is the case, it will cost the asset manager (and thus the client) much less to provide. As long as the asset manager makes it clear in his report to his client the basis upon which the report is calculated, there should not be a problem.

This means that another aspect of any new system should be that it can do both Transaction Based Performance and Holdings Based Performance as this will allow the fund manager to reduce running costs. Because of this, the supplier also needs to provide corporate actions and end of day valuations. That way the asset manager will just need to provide the daily holdings for the relevant portfolios and the rest can be provided by the supplier. The beauty of such a service is that implementation can be calibrated to meet the required return on investment for the project.

At the moment, most projects face what seems like a fairly daunting choice of either going for the simpler route of Holdings Based Performance but thereby making it impossible to provide Transaction Based Performance for fussier clients, or having to swallow the cost of taking on Transaction Based Performance for all their portfolios and running the risk that the project will last months if not years before any benefit (like reporting to their clients) becomes apparent.

Using this Performance as a Service should also mean that the client can get lots of other things done by the supplier. Risk measurement, attribution, compliance, GIPS composites, client reporting and other services all work off the same basic data and it is uneconomic for every asset manager to try and do it all themselves. Inevitably, it will be the smaller companies that will see the benefit of leveraging the expertise and capacity of a supplier that can do all of these things, but over time, the larger companies will wonder why they didn’t do the same themselves.

So in summary, in order to provide the benefit of excellent and flexible performance measurement that will help an asset manager win and keep clients whilst minimising the cost of this service, the supplier needs to provide the IT platform, the index data, the corporate actions, the end of day valuations and the option to choose between Holdings Based Performance and Transaction Based Performance per portfolio as a first step. Once that is done, the bells and whistles can be added. Not providing these basic services is like selling a car that runs on coal to power a steam engine.

Now where can I find a supplier like that?

When box ticking goes too far

“Computer says no!” is how I felt when told of the decision of Institutional Shareholder Services (ISS), a subsidiary of Riskmetrics, to declare that all our Non-Executive Directors (NED) were not “independent”.

Regulations are supposed to be a good thing, but of course, they can have perverse results like anything else. It is very difficult to create rules that produce sound judgements every time. People who are asked to review broken systems and propose new regulations end up compromising something in order to achieve the greater good. I would, however, hope that the application of rules and regulations could be framed within some guiding principles laid out by the authors. That way, future generations can understand the spirit of the law not just the letter. The American Constitution sets out fundamental principals that help guide all laws in USA. In the same way, the corporate governance rules that apply to UK stocks ought to set out the over-riding principals so that when there is confusion and conflict, the rules can be interpreted better.

I would say that the overall objective, of the corporate governance rules in the UK, is to protect the majority of shareholders’ interests versus the vested interests of select groups of shareholders and/or the management. The objective being that whilst there are always disagreements about strategy, there should be clear agreement that the main objective is to create value for all shareholders equally.

The biggest problem faced is an over-mighty Chief Executive who appoints yes-men to the board whom he or she easily dominates. For this reason it is considered essential that non-executive directors who are independent of the CEO are in the majority of the board so that the executive can be held in check. For an example of superb corporate governance see RBS, HBOS and Lloyds.

Greater minds have looked at this problem and tried to look for clues that might suggest that a non-executive director is not “independent”. One clue appears to be that if the non-executive was once employed by the company, he or she might be more inclined to side with or sympathise with the executive team. Personally, I doubt this. I would have thought that ex-executives are more likely to be a proverbial pain in the neck to the “junior ticks” who take over running things. But nevertheless, the impression of cosiness between old pals is deemed to outweigh the real benefit that ex-executives actually know the business very well and will know when the CEO is being completely candid or not.

Another rule of independence is whether the NED owns no more than 3% of the company’s shares. The worry here is that a scheming NED might sway the agenda of the board towards the benefit of his, or her, own interest. I believe this to be nonsensical as there is a presumption of guilt. A shareholder is a shareholder. If you have shares you will want to maximise the value of them. Of course outright fraud is possible, but to consider someone suspect because they own too many shares in the company they serve strikes me as arbitrary. I am sure that a NED with 3% of the business is going to pay a lot more attention to what the CEO proposes than a NED with a nominal holding. If a NED with 3% of Lloyds TSB had sat on the board would they have backed the purchase of HBOS? I very much doubt it. The acquisition made sense for the executives as their personal wealth and power was bound to benefit, but it was pretty clear that the acquisition would destroy value for Lloyds’ shareholders in the short, medium and probably long term, which is why the announcement of the acquisition was followed by a massive fall in the Lloyds share price.

So this brings me to the current situation for StatPro Group plc. For a start StatPro is a small cap business (circa £40 million market capitalisation at the moment) on AiM. As we are on AiM the governance rules do not apply. However, we try to abide by the rules as much as possible and in consultation with our NOMAD. Where complying would be overly burdensome and expensive or clearly irrelevant for a small business we adopt a pragmatic approach that sticks to the spirit of protecting Shareholders interests, which for me includes not wasting their money on meaningless exercises. After all rules devised for vast public companies with a market capitalisation of £10 - £100 billion are unlikely to be exactly suited to a flotilla of micro-cap companies worth between £10 - £100 million.

There is a significant quantum difference between the smallest and largest quoted companies. For example, paying a director of a business with £10 million revenue £150K salary might seem perfectly fine, but would you pay £150 million salary for someone to run a £10 billion revenue company? Given some pay awards, it is probably best not to answer that question, but let’s just say that the scale of a big business can result in excessive rewards being handed out to an individual without obvious material loss to the shareholders. Thus it is potentially much easier for executives to line their pockets at the expense of shareholders without causing sufficient harm to ruin the business. Shareholders therefore need NEDs to be on their side in the remuneration negotiations and on major strategic forays such as vain-glorious acquisitions. In other words, with Footsie 100 companies the executives are entrusted with such vast resources it is essential to have a little policing of how they carry out their administration and that they don’t abuse the great responsibility they have been given. Not very different perhaps to MPs and their expense claims…

With a company the size of StatPro, however, there is simply not enough meat on the carcass to argue about who gets what share. There can only be one objective: make StatPro worth more and as such we need NEDs to help fulfil that objective. StatPro’s NEDs are there to give advice, provide support and guidance as well as ensure that good corporate governance is maintained. They have to be fully engaged in StatPro and end up working many more hours than they are actually paid for. It is in fact very hard to find people who are willing to devote so much time and energy to a small business for quite small financial reward and significant penalties should things go wrong. This is why the best NEDs of small companies are independently wealthy individuals with experience of running and building small companies. If these people are not interested in buying the shares of the company, then what are they doing as directors? It can’t be for the annual fee, the risk-reward ratio doesn’t add up.

Our Board consists of two executives (Andy Fabian the Finance Director and me) and three non-executives with Carl Bacon the Chairman, Charles Fairbairn and Mark Adorian. Carl is an expert in performance measurement which is our business, Charles is a financial expert and Mark is a proven entrepreneur. Thus our board has a rounded set of skills where Charles matches Andy on finance and Mark matches me on business and strategy and Carl provides insight into our clients’ needs and the market place.

When Mark joined the StatPro board in 2002 he had 50,000 shares. Since then he has bought more and more shares in the market so that now he has over 2.5 million shares. You would have thought that this proves his complete alignment with other shareholder’s interests, but no, as he has 4.2% of StatPro the rules say he is not independent and so ISS are forced to recommend to our shareholders that they don’t vote for his re-election as a director of StatPro.

Carl was briefly employed by us to work 2-3 days a week so that StatPro could benefit from his industry expertise. For this reason he was executive Chairman for a short period. When he had finished this work he reverted to non-executive Chairman. The rules say that if you have been executive, you are not independent, thus ISS feel they must recommend that Carl is not re-elected as Chairman.

Charles stepped into the breach as acting finance director in 2000 for 3 months whilst we searched for a new FD. Apparently this brief stint as executive again forces ISS to say that consequentially he is not independent.

RBS famously had wonderful corporate governance yet the board managed to let Sir Fred destroy more shareholder value in less time than almost anyone in history. It probably would have happened whatever rules were in place, because these things sometimes do happen. However, StatPro and companies like us need a different set of rules and completely different types of directors to nurture us. In other words, the NEDs of big companies are there to be policemen, but the NEDs of small companies are there to be, well, Directors: offering advice and support. I believe the code should reflect this and perhaps someone should draw up a specific code for AiM companies.

Happily, we have spoken to our major shareholders directly about the false conclusions of ISS (a service most of them subscribe to). They have all been supportive and will not follow the recommendations of ISS in this instance. ISS is only applying the rules not making them up and I am sure there are many occasions when ISS provides invaluable benefit to shareholders bombarded with proxy forms, but they would be able to do a better job if the rules were better formed in the first place.

Money Weighted versus Time Weighted Attribution

In one sense there ought not to be too much discussion about the relative merits of money-weighted or time-weighted attribution, the attribution methodology must be consistent with the methodology used to calculate the total return of the portfolio, hence for time-weighted returns use a time-weighted attribution methodology and for money weighted returns use a money-weighted attribution methodology.

Perhaps a better starting point therefore is a broader debate about the relative merits of each return methodology.

It is received wisdom in the performance measurement industry to assume that time-weighted rates of return should be used to measure the return of the manager and money weighted rates of return to measure the return of the client. Indeed, before I thought deeply about the subject I would have agreed. Its easy to see how this view developed, the progression from money weighting to time weighting is driven by the need to measure the performance of assets managers accurately and compare their performance with other managers, hence the desire for true time-weighted returns.

However, the logic then follows that if time weighted returns are appropriate measures for asset managers then money weighted returns must be appropriate for clients. This is a false step in logic; Darwin[i] was right you can’t turn round and crawl back up the evolutionary ladder. We must analyse money weighted returns in isolation not as an automatic alternative to time-weighted rates of return. They do have one advantage that is prized by many; if there is a gain in value in the portfolio then the IRR will always be positive and if there is a loss the return will always be negative irrespective of the cash flow experience.

But does a constant rate of return make sense? It’s an artificial construct useful for forward looking analysis but not for retrospective analysis, we know investment returns are not constant, and we shouldn’t expect the force of return to change simply because we vary the time period of analysis.

Therefore in terms of choice for the client return we must choose between the constant force of return required to generate the end market value or the rate of return we would have achieved had there been no cash flows. In the context of attribution analysis the decision is clear; we are analysing the decisions within the portfolio taken by the manager; we don’t want the weight of total portfolio money to change the attribution result. Ask yourself the question, would the investment decisions, asset allocation and stock selection been different, had a different amount of money been available; almost certainly not.

By all means calculate both the money-weighted and time-weighted total return at total portfolio level and describe the difference between the two as a client timing effect (although in truth it’s a combination of many things including methodology differences)

Incidentally if the money-weighted return (or client return) is greater than the time-weighted return (or manager return) it does not necessarily imply the timing decision is positive; it really depends on the alternative investments available to the client. If the client could have made more money investing in the alternative then the timing decision is not good even if the money-weighted return is greater than the time-weighted return.

Proponents of money weighted attribution take the false step in logic that control of cash flow requires the use of a money weighted return one further step by suggesting than since managers control internal cash flows then money weighted returns must be more appropriate. As demonstrated in the following example (the data chosen incidentally by the proponents of money weighted attribution to demonstrate their case) true time weighted attribution is able to correctly allocate stock selection and allocation effects of the manager.




Because there are no external cash flows in this example the total return is same for time weighted, modified Dietz or IRR methodologies i.e. 100%

For the entire period the returns for each security are:


























To reconcile to a return of 100% the weight in security A must be 68% and the weight in security B must be 32%
68% x 113.79% + 32% x 70.62% = 100%

Actually in this simple form you don’t have to use an iterative method, the solution to the quadratic equation can be found directly using
Where


In this case set




To generate attribution results lets assume a benchmark of 50% in Security A and 50% in Security B

Using the arithmetic Brinson & Fachler methodology including Interaction with Stock Selection the attribution results are as follows:




























Neither the modified Dietz nor the IRR money weighted attributions make any economic sense; most of the added value appears to be stock selection. This simply cannot be true since the performance of both security A and security B are the same in both the portfolio and the benchmark. The time-weighted attribution correctly illustrates what is happening in this portfolio. For the initial sub-period the portfolio and benchmark are exactly in line. For the subsequent sub-period the portfolio manager has taken an asset allocation decision to be overweight security A and underweight security B. Incidentally the benchmark weight for the subsequent period must reflect the performance of the underlying assets i.e. 20%:80% not fixed back to 50%:50%. We can be confident this is correct because the period benchmark returns compound to the total period return 1.25 x 0.8 - 1 = 0%

The modified Dietz return is fairly standard, I’m not sure it’s appropriate to show the IRR attribution at all. The attribution results in both the modified Dietz and IRR method are typical, random distribution between stock selection and asset allocation and the consequent loss of information.

In summary time-weighted attribution is currently the dominant form of attribution and it should remain so because:

i) In most cases at portfolio level the time-weighted return methodology is the most appropriate methodology to measure portfolio performance. (Primarily to allow comparison between managers with different cash flow experience)
ii) Internal Rates of Return assume a constant form of return which is not only unrealistic but counter-intuitive in the context of return attribution
iii) Investment decisions are the same irrespective of the amount invested.
iv) The portfolio manager’s control of cash flow timing is a spurious argument in favour of the use of money-weighted returns. Time-weighted attribution methodologies are perfectly capable of measuring manager’s timing decisions.
v) Money weighted attributions misallocate attribution effects between stock selection and asset allocation effects.

Building a compliance culture in turbulent times

Executive summary

The Financial crisis has focussed investment firms more than ever on the need to better monitor and manage risk. The conveyor-belt of ever more complex investment products has slowed and firms face increasing levels of scrutiny from both regulators and customers. As a result, the need for a better understanding and tighter control of risk has moved rapidly to the top of the agenda for most investment firms.

While the market now acknowledges that the financial crisis has highlighted a failure in the monitoring of risk and that the current regulatory environment is not effective in mitigating risk, it remains to be seen how regulators and investment firms will respond. What is clear is that investment firms will require a more pro-active and inclusive strategy to compliance. However, compliance risk specifically is often less understood by senior management than other areas of risk, creating a gap between the firm’s business strategy and the implementation of the appropriate compliance processes.

In this paper I discuss how it is possible for investment firms to learn from the mistakes of the past and bridge this gap successfully, and most importantly, within a reasonable time frame and budget. The good news for investment firms is that with a clear strategy for implementing compliance processes, the compliance function will soon be adding real value to the investment firm and ultimately enhancing and protecting its brand.


Building a compliance culture

Risk strategies now need to include a clear focus on compliance risk, that is accurately and consistently monitoring and managing the variety of risks that the investment firm and their customers are exposed to, as well as reporting on the status of compliance risk to all stakeholders including management, regulators, auditors and customers. To successfully bridge the compliance gap mentioned earlier, the compliance division must move away from the traditional reactive approach to compliance and play a move active role in the investment firm’s overall risk management processes. To achieve this in practice, investment firms committed to best practices in compliance are empowering their compliance division to play a more active role in defining the risk strategy and implementing the risk monitoring processes across the organization.

A new vision for managing compliance risk is required and investment firms are now recognising that it is simply good business practice for a company seeking standards of excellence to step beyond the reactive tick-box approach and introduce a compliance culture, involving all employees at all levels. A business culture in which investment firms value and promote a compliance culture can have positive effects beyond adding value to the investment firm’s brand, playing an important role in preventing potential misconduct and promoting ethical standards which in turn contribute to fair and orderly markets in which consumers, firms and regulators can all have confidence.

Investment firms are restructuring the compliance function away from an isolated checking function towards a more co-operative approach or in some cases merging the compliance and risk functions, where an effective strategy can be put in place to monitor all the risks faced by the business. This co-operative approach requires a compliance culture within the investment firm starting at the top and with the ultimate goal of enhancing the firm’s brand and protecting the reputational risk of the firm. The compliance function should be structured, resourced and operated in a manner which fosters integrity and efficient operation and the compliance officer should have the necessary authority and responsibility and should report to the governing body in respect of that responsibility.

In this new model the compliance function is responsible for creating an environment of continuous improvement where compliance processes move beyond today’s requirements and look to new trends and further ways to add value to the business. Specifically, the compliance function is responsible for implementing effective processes to monitor and manage traditional compliance checks such as client mandate, regulatory and in-house checks as well as the various portfolio analytics and risk measures that are calculated across the business. Whether it is derivative exposure, VaR (value at risk), expected shortfall or tracking errors, the compliance and risk teams need to co-operate to ensure that all the relevant risks faced by the business and its clients are monitored effectively. In addition, compliance can play a crucial role in monitoring the integrity of data used by the business ensuring consistent and accurate results. The compliance function is responsible for monitoring absolute and relative deviations from targets or benchmarks and ensuring effective communication and resolution of any breaches that occur.

Where the compliance function is outsourced the investment firm needs to be careful not to lose sight (and possibly control) of its risk management strategy and should continue to focus on building a compliance culture to implement that strategy effectively. The investment firm remains responsible for protecting the interests of its customers and must continually be aware of and monitor the processes of the outsourcer to ensure that they remain appropriate for the changing needs of the investment firm.

As investment firms become more specialized, so the nature of the risks that the investment firm is exposed to diverge. This trend emphasizes the need to build compliance processes that are aligned to the exact nature of the risk profiles of the different areas of the business. A Hedge Fund, for example, will be more interested in monitoring portfolio analytics and risk measures than regulatory rules. Multi-Managers will need to monitor a variety of different types of rules at manager, product and client levels while firms with retail products will be focussed on compliance with the relevant regulations. Where investment firms combine various different investment activities, an integrated system for monitoring, managing and reporting across all the business areas (with appropriate ‘Chinese walls’) will provide real benefits to the investment firm in understanding the status of compliance and implementing a consistent compliance process as well as building a compliance culture across the business.

One of the key challenges in achieving an integrated compliance process across the business is managing the various different sources of data in the different business areas. Many compliance implementations have stumbled at this data hurdle resulting in the compliance team feeling like their ‘hands are tied’ by data limitations. The good news for compliance teams is that the new breed of specialized compliance systems, such as StatPro Portfolio Control, typically provide tools to integrate and manage data, enabling the compliance team to focus on managing the process rather than spending their valuable time resolving data integrity issues.

As investment products become more complex and possibly expose customers to more risk it is critical that the investment firm has the tools to effectively calculate the risk exposure of their customers as well as to monitor and manage those risks. In response to the increasing risk profile of investment products and some high profile failures, regulators in some regions have published detailed regulations governing the investment marketplace and well as increasing their attention on the ‘policing’ of the market. These regulations, such as UCITS III in Europe, have had a major impact and helped to define best practice in the industry to date although the more compliance focused investment firms will acknowledge that regulations are just one part of their compliance process and as such should not be the driving force in the firm’s compliance strategy.

It will be interesting to see how the Financial crisis drives future regulations although the more savvy investment firms understand that in fact, today’s best practices by investment firms often become tomorrow’s regulations. This was confirmed in a recent global survey of senior executives in the industry which revealed that compliance with government and industry regulator rules is seen as less important in avoiding reputational risk than internal codes of practice. The survey also emphasized that compliance risk, together with reputational risk, have overtaken more traditional risk areas, such as credit, market and financial risk to join operational risk at the top of the investment firm’s agenda.

The uncertainty around the direction of future regulations and the appropriateness of compliance processes emphasize the need for investment firms to fully understand the risks faced by their business, set related tolerance levels and implement appropriate measures and processes to monitor and manage those risks including employees’ compliance with them. An isolated compliance function will not be able to understand and translate the variety of different risks across the business into a clear and concise compliance implementation. To achieve this compliance checks and processes must be aligned to the strategy of the organization – in other words, there must be a culture of compliance throughout the investment firm, starting at the top.

Building a compliance culture in the investment firm requires effective communication of the status of compliance across the firm at all times. Effective communication means presenting clear and accurate information to all stakeholders including clients and regulators, as well as getting the balance right between distributing too much or too little information. Getting that balance right and ensuring that the communication is appropriate and consistent with the investment processes of the firm requires a compliance culture that encourages co-operation across the business and can be enhanced using technology tools such as email and easy to access web-based enquiries.

Investment firms are spending more on compliance than ever before and the results from the increased expenditure have often not met with the expectations of management. New compliance systems provide flexibility through sophisticated tools to enhance the compliance process but building an effective compliance culture across the firm is the key to ensuring that such systems are implemented effectively and that value is realized from the increased expenditure. Investments firms looking to reduce costs but not compromise on quality are also considering how SaaS (software as a service) can provide quick savings and enhanced service delivery. Software firms such as StatPro are now offering SaaS solutions, effectively providing a specialized outsourcing solution including IT infrastructure, software and third party data required for compliance and risk monitoring, reducing the total cost of ownership by 30% or more.

Implementing systems that can automate the compliance monitoring process are critical to be able to manage the complexity and volume of today’s monitoring requirements. Best practices require daily automated compliance monitoring processes supplemented by intra-day and pre-order checks to identify, communicate and resolve breaches as soon as possible. Automation should go beyond checks and balances to the process of managing and resolving breaches. Building a systems workflow that is aligned to the business process will ensure that high priority scenarios are highlighted and the appropriate people are always informed of the status of compliance. A full and detailed audit trail is also critical to tracking and reporting all stages of the compliance life-cycle.

Experience shows that the successful implementation of compliance processes is often compromised by the sometimes conflicting requirements of the front or back office so it is critical that new compliance systems provide tools geared towards the specific needs of the compliance team and empower them to meet 100% of the monitoring requirements as well as report effectively to all stakeholders. Complete and accurate data for compliance purposes is one of the key challenges in successfully implementing a compliance system and the tools referred to above should include the ability to manage the extensive range of data from a potential variety of different sources that is required to monitor all the checks and risks across the business. Data management should also include checks and balances to ensure the integrity of data, with any exceptions being highlighted as part of the compliance process. Further, the complexity and varied nature of the different monitoring checks mean that compliance systems require additional and enhanced data. New ‘best-of-breed’ compliance systems, like StatPro Portfolio Control, provide the ability to manage and enrich the data required for compliance checks to ensure the accuracy and reliability of the data which will enable a successful compliance monitoring process and will give all stakeholders confidence in the results.

In summary, building a compliance culture that extends throughout the investment firm will deliver wide ranging benefits that will ultimately improve the brand of the investment firm and protect the firm’s reputational risk as well as enhance service levels to customers. The compliance culture starts at the top of the organization and is implemented by a compliance team that is empowered and responsible for successfully aligning risk monitoring and management processes to the business strategy. With the right focus, this new model can be implemented quickly and cost-effectively and will start delivering immediate benefits - a compliance culture is a culture of successful business practice!

The Real Cost of Software

A quick analysis

Software costs money. This cost is pretty visible, you get an invoice from your software vendor depending on the model; one off license costs, annual support agreements, annual subscriptions, upgrades etc. It’s even fairly simple to track some associated costs of your new software, like the server hardware required to run the software and the server software licensing costs. Beyond this however, it gets a little cloudy when trying to piece together all the associated costs of departmental software applications. No matter how small you think an implementation will be you will always incur costs when maintaining a platform for software.

Okay, let’s look at an example. Before we start it’s important to understand the main assumptions made so the numbers below make sense. The example is based on the following assumptions;

• The application is a departmental application requiring a live production system, a failover system and access to a test system for doing user acceptance testing with new versions etc.

• The application will be deployed on physical server hardware in a single data centre site.

• A major release upgrade will be taken and deployed every 18 months.

There are additional assumptions made on hardware costs, hardware maintenance and internal management costs. Details of these costs are given below the example.



As you can see, the above figures do not include the purchase cost of the software in the first place. These costs represent the additional costs incurred when maintaining software applications in-house. They are real costs and are very easily blurred into the day to day costs of running a business. This need not be the case – these are not costs of running a business, these are costs that have been chosen during the decision to run an application internally versus hosting with an external provider. Many of these costs can be eliminated and replaced with lower external hosting costs simply by switching to a hosted platform rather than an in-house system.
On this example above, switching to a StatPro hosted service would save over 50% on the annual costs of maintaining an in-house system.

Notes on costs

1. Based on the annual lease cost of three physical 2 CPU quad core servers with local memory and disk storage.
2. Based on 20 hours required to procure, prepare and provision each server with a labour cost of £28.23 per hour.
3. Based on the cost of server administration management time for tasks including change management, problem and incident management, monitoring, performance and availability management, asset management, security management, patch and upgrade management, backup and recovery, restores, storage management, disaster planning, compliance management/reporting, vendor and contracts management and financial/budget management. Based upon 3 server workloads consuming 8% of a server administrator’s overall workload (average of 40 workloads managed per administrator staff) over the year with the burdened labour cost per server administrator being £54,578.
4. Based on the annual cost of backing up 30GB of data to an off-site facility at a cost of £8 per GB per month. Includes 10% data growth per year.
5. Based on the annual cost of software assurance licenses for MS Windows, MS SQL Server, MS Office and 5 user access licenses.
6. Based on each server requiring 516 Watts of operating power and 645 Watts of cooling power at £0.0646 per kWatt hour.
7. Based on one server rack in a data centre facility consuming 23 square foot at an average annual cost of £205.05 per square foot.
8. Based on an average of 14 days a year consulting from the application vendor during application upgrades and maintenance releases at a cost of £1,350 per day.
9. Based on an average of 6 days a year of internal IT project management with a burdened labour cost per project manager of £500 per day.
10. Based on an average of 13 days a year of internal business unit project management with a burdened labour cost per project manager of £500 per day.
11. Based on an average of 5 days a year of internal IT application support requirements with a burdened labour cost per application support resource of £500 per day.
12. Based on an average of 3 days a year of internal IT training time for new/replacement application support resources with a burdened labour cost of £500 per day.
    

Asset Managers need to reduce their costs – SaaS will help

Why StatPro is evolving its business model

Time changes everything. What was once state of the art becomes a cumbersome nuisance at some point. The explosion of activity that occurred in the 90’s when hundreds of small software companies built applications to sell to asset managers allowed a big increase in efficiency. Processes that had taken weeks were reduced to hours or minutes. New processes that were impossible dreams became a reality. This was all possible because of windows and Visual Basic and the process was not unique to asset managers but affected every business sector. By comparison the Dot Com boom did not reach the business community but was aimed at the retail market and when it busted prematurely, development slowed.

So today the IT landscape of the Asset management industry is one where any company of any size has 10 to 20 important systems upon which they depend for a variety of essential services. The majority of these systems are all provided as software that is installed on the company’s own servers in their own IT centre. They will probably have many other applications of less importance that they run as well. The result is that they have large IT teams, complex processes and relatively high costs.

Some companies have tried to outsource the whole thing to a third party such as a custodian or IT services provider. However, there are many horror stories that warn this is not a simple solution. In fact the rule of thumb is that if your IT department works well and efficiently, you can outsource it, but if it is inefficient you can’t. The outsourcer cannot be expected to unravel your mess.

What has worked however is selective outsourcing. This typically means getting the supplier of your system to host their own application. This makes sense as the supplier ought to know how to support their own product and if they do this for all their clients, they can get economies of scale which a generalist outsourcer cannot hope to achieve.

The other factor is that Web 2.0 has unleashed a new revolution in IT making it possible for suppliers to provide “Software as a Service” (SaaS) solutions over the Internet and with relatively low cost. Incumbent suppliers are reluctant to adopt this new technology as they fear cannibalisation of their existing business and because they calculate that such is the complexity of the processes that surround their embedded systems, clients will be loathed to move anyway. That leaves the door open for start-ups, but this generation have a much bigger battle than the class of ’95 as the standards and functionality they have to match are significantly higher and the gains in efficiency are less about time and volume and more about money. Clients want the same for less rather than more for the same.

This is the thinking behind StatPro’s own strategy. We believe that eventually all our clients will want to access their services over the web just in the way that we all use email rather than a fax (or telex, or telegram). Indeed, email is fast being superseded by instant messaging. However, we also recognise that clients cannot simply throw everything out and start again, but rather need to evolve in a sensible direction according to a plan that has been tried and tested. The last thing anyone wants to do is jeopardise their business for the sake of saving a relatively small amount of money.

This means that we have focused on deploying new services and products that offer quick savings for clients whilst moving them towards the strategic objective of low-cost web-based applications.

StatPro has built a solid reputation as a supplier of Data for valuations and Analytics systems that cover Performance, Attribution, Risk, Compliance, GIPS and Reporting. Right now, most of StatPro’s clients deploy our software on their own servers. They feed the software with index data and market data from third parties and finally with their own data. The result is that the cost of the software we supply (on a subscription basis) amounts to less than 10% of their total annual cost of ownership in most cases. IT costs are about 10%, data supply will be about 30% and 50% employee costs although some of those employee costs relate to managing IT and data.

We are in a position to offer our clients the IT platform and the third party data and we believe that by doing so we can reduce the total cost of ownership to 70% or less of what it is despite charging additional fees for IT and data. This is because we can offer the IT platform together with the index and market data at a very low rate.

Apart from saving our clients money, we will also improve their service as we will have direct access to their system in the event there is a problem. We will also save our clients further money because we will not have to charge them to upgrade their software. The clients will receive upgrades when we are ready, not when their IT departments are ready. Overall, the complexity of process and the management time required to follow it all will be slashed so there will be other hidden savings and benefits. If a client buys more products from us to replace legacy software we will offer further discounts and savings.

It is also important to note that it will be easy for the clients to take this new service as it is a simple matter of us putting their existing system on to our platform. From there we will upgrade them progressively and, from their point of view, painlessly.

The second stage in our strategy is what we call SaaS2 which is a SaaS product built from scratch. This product takes full advantage of all the latest technology as well as our accumulated knowledge about our products. Once the platform is launched however, it will be relatively easy for us to migrate clients to it from the SaaS1 platform if they wish to use it. This new platform will be released in beta form during 2009 and go live in 2010.

Many asset managers must be thinking about SaaS as a way to reduce their costs, but the obstacle they will encounter is the complexity of getting there and doing so for a wide number of applications. We believe that our approach offers a strategic shift with clear and immediate savings whilst laying the groundwork for the final move to a pure SaaS platform which in turn will allow greater savings.

Justin Wheatley
Chief Executive StatPro Group plc

Setting the Standard

Author: Neil Smyth

When deciding to outsource or host software solutions with vendors it pays to know how they intend to deliver such a service. Software vendors write software, what makes them capable of hosting that software for their clients?

When you choose to host your application with the vendor you are asking them to take on much more than their traditional responsibilities. You are effectively asking the vendor to take on the role of your in-house IT department. How do you ensure that the vendor is able to handle this new burden and maintain the availability, security and integrity of the application and more importantly, your data?

Understanding the vendor’s ability in this area can be hard to do. Long winded RFP’s take time to analyse and without going into second stage of Q&A sessions with the vendors IT department you still can’t be sure on the level or standard of service. Even with detailed levels of analysis you are still only getting the vendors point of view and not an independent opinion on their ability to securely host your data and ensure it is available when you need it.

Having an independent opinion and assessment on your vendors hosting service is the only way you can know they are taking their responsibilities seriously and have the processes and ability to deliver on those responsibilities. This is where recognised standards should play a key role in your decision to host with a software vendor. The next question is which standard? When it comes to hosting applications and information security there are only two you need to look for. ISO27001 and SAS70. These are the big boys and anyone telling you that they have others that are more stringent or more relevant obviously do not meet the requirements of ISO27001 or SAS70.

Knowing your vendor has been independently audited and certified gives you the confidence that they have invested in putting the right processes, people and technology together for their hosted service. Not only does the vendor have to demonstrate this to the auditor, they have to continue to demonstrate the process and show a continuing cycle of improvement across the standard.

Trusting your data and application delivery to a third party requires you have a high level of confidence in that third party. Placing that trust in the software vendor makes sense, but only if they can demonstrate they have the ability to deliver on the extra responsibilities that trust will bring. A vendor with a trusted and recognised certification in information security should be your minimum requirement when switching to a hosted service.

Neil Smyth is the CTO at StatPro – a leading provider of analytics software and data for the investment management industry.