VALUE provides cross-asset coverage for real-time net asset value and risk calculations. It gives hedge fund executives a real-time view of all operations, including pricing, position keeping, processing, data access and data transfer to other systems. Also offered are standardised connections with various third parties, notably prime brokers and administrators, to accurately reconcile transactions, positions and cash balances.
“The value proposition we have for hedge funds is to allow them to be totally in control of their P&L,” says Sebastien Roussotte, the Misys Sophis chief operating officer for the UK and Scandinavia. “It also allows them to be in control of their exposure and manage the risk associated with the portfolio. The benefit to the portfolio manager is the complete visibility of the portfolio. Investors will benefit, too, as the application enables the creation of a number of reports that provide transparency about how hedge funds are managing their money.”
Buy side market share
One of the primary reasons for Misys acquiring Sophis is its strong presence among buy side clients. Misys plans to continue investing on the buy side and to bring knowledge from its TCM (Treasury & Capital Markets) division – in particular Misys Summit – to the buy side. This will allow the enlarged group to cover more asset classes on the buy side (See Fig.1). What’s more, Misys will use its substantial research and development resources to invest in more buy-side functionality. Adding the knowledge and experience from Sophis, which is being run as a separate division alongside the Misys Banking and TCM divisions, will enable the combined operation to provide more comprehensive coverage.
During 2010, Sophis signed over 20 new buy-side customers, including six European hedge fund firms. That takes its client total to almost 100 institutions. This includes 13 of the top 20 asset managers worldwide by assets under management. It is expected that the link-up with Misys will help Sophis expand its buy-side presence in Asia, Africa, the Middle East and Eastern Europe. There is an aggressive timetable to integrate Misys Summit and Sophis RISQUE, and to enhance Sophis VALUE’s interest rate capabilities and coverage by mid-2011. The next step, due for completion in 2012, will be to integrate the service-oriented architecture technology so that the enhanced platform can be targeted to both buy side and sell side clients.
Product development
Sophis began the development of VALUE in 2002. It evolved from a risk management application the firm created over 20 years ago for its first software product developed for investment banks. That front to back office application was Sophis RISQUE. In the late 1990s, Sophis identified a need among large asset managers on the buy side, including hedge funds, to manage risk more adroitly. The events surrounding the collapse of Long Term Capital Management served as a catalyst for fund managers to have a system that could give them visibility on position exposures and thus allow risk to be decreased. Pressure from investors for better risk controls convinced Sophis that there was a substantial appetite for a system dedicated to giving transparency on risk. The development of VALUE for buy side clients built on the financial libraries Sophis had used for 15 years with investment banks. The graphical user interface is different for the applications used by investment banks but the underlying pricing libraries, data models and terms are the same. This meant Sophis was able to develop an application specifically for hedge funds very quickly, which it began selling in 2004 to hedge fund firms, mainly in London and New York.
“The application we now sell to hedge funds is a result of the specific development of the product for investment banks over 20 years,” says Roussotte. “With investment banks extracting their proprietary trading activities this is leading to the creation of hedge funds which are obviously potential customers,” he says, adding that Misys Sophis is currently working with a couple of prop desk spin-offs from big US investment banks. “The trend in the investment banking industry to spin off prop trading activities is well established. These traders want the same tools they used when they were trading at the investment bank. There is a direct link between the activities of investment banks and what is happening in hedge funds. This is one of the reasons why we have been successful in marketing to hedge funds.”
New version
The recent launch of VALUE 4.1, its latest version, is expected to help Misys Sophis continue to add clients across the buy side industry. One of the solution’s characteristics that appeals to hedge funds is its very specific work flows. Since Misys Sophis maintains links with all the prime broker platforms, on the front office side it means that executed orders can then be uploaded directly to the Sophis application. On the back office side, since all hedge funds need to have a fund administrator, implementation is done quickly in order to ensure the delivery of an effective STP solution to hedge funds. This connectivity is a key advantage of the solution.
A second benefit is the solution’s contribution to risk managing the hedge fund portfolio. “The financial crisis and the failure of some hedge funds means that it is absolutely critical to have a risk management methodology in place to attract new investors,” says Roussotte. “There isn’t any sale to a hedge fund customer now that doesn’t involve a strong focus on risk management that will be directly overseen by the partners of the firm.”
A third important piece of the solution’s utility for hedge funds is the function to generate reports for investors. This gives managers the capability to do benchmarking or chart performance and distribute that information directly to investors. Strong cross-asset cover is also provided to hedge funds across a wide range of instruments. Though funds may be specialised at inception, it is useful for an IT solution like VALUE to be adaptable to a wide range of strategies since what hedge fund firms offer is likely to evolve according to market opportunities.
Quick installation for start-ups
For a start-up hedge fund, it takes about three weeks for the entire VALUE system to be implemented. Typically, this involves three phases executed concurrently. They are: 1) advising and installing the software; 2) providing connectivity to prime brokers and the administrator; and 3) training staff and transferring expertise.
In the first instance, a professional service team from Misys Sophis meets with the portfolio mangers to understand the strategy, trading activity and transactions that are envisaged. If all of the instruments are relatively standard it can take just a few days to set up and activate all the right modules. When some of the managers are designing very complex trades it can require a bit more time to understand how to apply the instrument to the software application. Connectivity is generally straight forward since Misys Sophis typically has interfaces and connections already designed for the main prime brokers and fund administrators. With a new fund, two or three users at the hedge fund are trained to be experts in operating the system. Misys Sophis is particularly sensitive to the fact that hedge funds don’t have big IT teams or, in many cases, mid and back office staff.
“Our customers appreciate the fact that we are very open and flexible in the way we operate,” says Roussotte. “When the portfolio managers start up the business they have a great deal to do, what with FSA and SEC approvals as well as the complex legal and business entities they are building up. They can’t focus on just implementing the system. So Sophis becomes their team during the set-up and implementation. Once things are in place and they can start trading then we transfer our knowledge and start training them to operate the system. I think hedge funds appreciate that, as when they are starting up they need to act very quickly to track their performance and communicate it to investors.”
Changes post-2008
A number of changes have affected the hedge fund market since the financial crisis hit in 2008. Prior to then, hedge funds were generally enthusiastic to trade complex products and wanted IT systems that had the ability to adapt to new financial products quickly. Post-crisis the blame that was attached to some complicated derivatives products saw a decrease in the interest for such products and a decline in demand for related IT applications. Now the functionality that has become much more important is risk management reporting for investors.
“Specifically with hedge funds in the US, which weren’t so interested in risk management before the crisis, this is clearly a must,” says Roussotte. “Hedge funds are now interested in VaR modules, the type of risk management methodologies we offer and stress testing. All of these functions are provided in the Misys Sophis software. The challenge for hedge funds now is to invest more in data.”
Typically, hedge funds require up to a dozen stress test case scenarios such as the 2008 liquidity crisis, the implosion of the dot.com boom in 2001 and the 1998 Asian debt crisis. In addition to stress testing, however, hedge funds are also using VALUE for more generic reporting capability on where the risk exposure is in the portfolio and knowing how this is concentrated with different countries and counterparties.
Calculating VaR
The calculation of VaR or value at risk is a mainstay of the system’s risk management module. It uses three traditional methodologies: parametric, historical and Monte Carlo. When a hedge fund uses the parametric methodology it needs a simple set of data, which has the sub correlation matrices provided by data vendors. Most Misys Sophis customers use the historical VaR methodology even though it requires much more data.
“When we implement this there are several days of work ensuring that the user can load historical data from vendors or from its own source,” says Roussotte. “It is more precise but very heavy on data consumption. Misys Sophis is also very strong on complex derivatives which use Monte Carlo simulations.”
Value offering
To provide a service for start-ups or funds that don’t want to deploy a system on their premises the firm has launched iSophis. It is a value proposition that gives hedge funds a pared down solution that stillprovides some risk management figures daily.
“What we are doing for these customers is using the VALUE software and we have built a mechanism where we can load their positions every day, process the results and send them back via a web report,” says Roussotte. “On their side there is no software or IT requirement. We just send them a risk management report. They get a service that is fully hosted and provides risk management figures showing the exposures of the positions held by the hedge fund.”
To any close observer of hedge funds, the breadth and depth of reporting requirements is something that looks certain to go on increasing. The growing use of UCITS funds looks certain to contribute to this trend. “The main impact of UCITS is that fund managers need to create more reports,” says Roussotte. “It is a large driver for us and for our software. Since this reporting is evolving you need a reporting tool that is sufficiently flexible and that can evolve. The Misys Sophis application meets this condition perfectly.”
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