By: Matthew Nelson, Tower Group
Published: November 2005

(editor’s note: At AllAboutAlpha, we do all we can to ensure readers don’t get stuck having to subscribe to or purchase the content to which we link.  Whenever possible, we find free registrations or provide a free alternative versions of any for-fee content that we cover.  However, we make an exception for this report from technology consultant Tower Group (MSRP: US$1750).  Regular readers have covered most of the investing themes in the report already.  But the report’s IT implications provide a different, more operational, perspective on portable alpha that we think is useful.  We briefly summarize these issues below). 

But to begin, Nelson sets the table well: 

“There’s a significant shift under way that is transforming the very nature of the investment management business…(Investors) are analyzing the data more carefully in an effort to separate the influence of the market from the value added by the manager. This practice has resulted in the explosion in size of pure index portfolios and managers like Barclays Global Investors and State Street Global Advisors, which have seen their assets under management (AUM) soar. Alongside this growth in index assets a groundswell has occurred in the use of alternative portfolio strategies and the notion has arisen that traditional, long-only portfolio mandates are becoming obsolete and that alternative portfolio strategies are the wave of the future.”

Then he goes on to describe three operational “challenges” of portable alpha:

Lack of a “true overlay manager”

“…implementing alternative portfolio strategies requires a single holistic manager to oversee the portfolio, monitor and manage risk and performance, handle transitions and short-term cash requirements, and deal with the individual managers.”

“(Leaders in this area) bring strong existing technology platforms, which deter entrance to this market because of the large volumes of information that a master manager would be required to aggregate, normalize, calculate, and present to the client.”

Trading, processing, and servicing alternative investments

“The explosion in the size of the derivatives market has been well documented…This increase has placed a tremendous strain on buy-side and sell-side back offices as the flood of deals, most of them over the counter, need to be processed, cleared, and settled.”

“Failure to improve the straight-through-processing (STP) capabilities in derivatives servicing, although it hasn’t significantly slowed the growth in derivatives as a whole, threatens to put a damper on the adoption of alternative portfolio strategies.”

“Portfolio and order management systems are likely to be able to handle many “vanilla” derivatives but will not be able to handle more complex products and strategies.”

Acquiring, managing, and maintaining reference data.

“The data providers to these asset classes tend to be niche players, not the large mainstream data providers like FT Interactive Data and Bloomberg.”

“Portfolio and security analytics, risk and performance, portfolio accounting, and reconciliation and corporate actions systems will be the most challenged within the investment manager’s IT infrastructure because of their strong reliance on reference data.”

We admit to spending a lot of time on theory on this blog.  So you might find this report’s emphasis on critical operational issues somewhat refreshing.  (especially if you’ve got $1,750 burning a hole in your pocket).

Tower Group 

For more information on the IT implications of portable alpha, contact Matthew Nelson directly at: MNelson@TowerGroup.com.