By aleksey matiychenko and alexander makeyenkov -- risk management is in vogue these days. The crisis of 2007-2008 has in many ways been blamed on the failure of risk managers to predict the stress that we have all now lived through.Cognitive learning activities with global markets rebounding and hedge funds posting positive results, the discussions about improving risk management policies and systems are taking place at many hedge funds.Cognitive learning activities

Hedge fund technology & trading (PDF)effective risk management requires that the firms establish culture, policies and procedures that are specific to their operating model.Cognitive learning activities however, at its core risk management is a quantitative discipline that requires significant investment in data, systems and people. In this article we discuss what it takes to develop internal risk management architecture.Cognitive learning activities

It’s been a long term practice in the financial services to use microsoft excel as a tool for both storing data and performing analysis. The growing complexity of financial products and the need to have robust systems make excel spreadsheets a less than ideal environment to store data.Cognitive learning activities to be truly reliable, the data used in risk management analysis should be housed in a relational database such as a MS SQL server or oracle.Cognitive learning activities

Whenever new systems need to be put in place, the usual question of build versus buy arises. There may be many factors that affect the ultimate decision to build or buy a system.Cognitive learning activities though price is often an important criterion, it should not be the deciding factor. There are many instances when a hedge fund should opt for a buy decision and avoid spending time and resources on internal development.Cognitive learning activities the buy decision is usually justified when implementing systems that aren’t specific or critical to the hedge fund’s core strategy. Such systems usually include: contact management, accounting, trade capture and others.Cognitive learning activities

The decision to buy or build a risk management system depends on the complexity of the hedge fund’s strategy and the variety of products traded.Cognitive learning activities most commercially available systems may be sufficient to analyze a certain range of products. Few systems are able to produce meaningful analysis of a diversified and complex portfolio.Cognitive learning activities even fewer do it well.

If anything can be learned from the current crisis it is that risk management needs to be part of a core strategy of any investment firm.Cognitive learning activities what this means is that risk management systems need to be part of the core strength of any hedge fund that wants to stand out. For such hedge funds, buying an off-the-shelf product may be a first step in developing risk management architecture, but it shouldn’t be the only step.Cognitive learning activities

Ultimately, all commercial packages are made to be able to satisfy the largest number of customers. Some packages can be customized to each client’s needs, but the customization effort may be complex, limited in scope and expensive.Cognitive learning activities we have seen such implementation at a number of hedge funds. The usual architecture involves a vendor risk management package such as risk metrics, measurerisk or others.Cognitive learning activities any risk management system (vendor or in-house) needs to be integrated with trade capture, portfolio management, and back office systems.

Depending on the complexity of the fund’s portfolio, the vendor system may not be capable of handling certain instruments.Cognitive learning activities in such situations, the solution may involve either building an internal system to handle these instruments or purchasing an additional vendor system(s).Cognitive learning activities we, in fact, have seen multi-strategy hedge funds purchase one system to handle equity products, a second system to handle fixed income, and a third system to handle exotic products.Cognitive learning activities ultimately, all these systems need to work together.

While ensuring seamless dataflow and building custom reporting that integrates all the systems is a big task in itself, there is an even a bigger issue.Cognitive learning activities at the end of the day, a risk manager needs to have a complete picture of portfolio exposures. Such a picture needs to incorporate correlations among various products that exist in disparate systems.Cognitive learning activities building a tool to bring all these exposures together is akin to developing a complete risk system from scratch.

Developing a risk management system is not a trivial process and is likely to take significant time and money.Cognitive learning activities human resources required to implement such a project typically require at least two, and likely more, highly-skilled professionals with graduate or post-graduate degrees and extensive software skills.Cognitive learning activities even in the stressed employment markets that we are experiencing right now, such individuals carry an expensive price tag. Hiring several such individuals may not justify the value added by the development.Cognitive learning activities additionally, a proper enterprise-level development effort will require investment into project management, quality assurance and maintenance practices, all of which will call for extra hires.Cognitive learning activities the solution to this may lie in outsourcing a significant part of such development to a firm specializing in such projects.

The in-house vs. Outsource decision does not need to (and perhaps shouldn’t) be mutually exclusive.Cognitive learning activities in order to extract the full benefit from the custom developed system, the fund should employ at least one of those highly-skilled risk professionals capable of modifying and maintaining the system.Cognitive learning activities having an outside vendor perform most of the development would ensure faster implementation.