To be honest, I remain skeptical about the necessity to invest heavily into Risk Management technology. It seems to me that the issue is not in software or hardware but in general assumptions and practices. Let’s take pricing and valuation - server farms
with thousands of servers running Monte-Carlo and stress tests for structured products did not help with preventing the mortgage disaster. Should the hedge funds spend scarce available resources to implement similar systems at this very moment?
On the other hand, it is encouraging to discover that Celent believes that hedge funds will work on improving their Smart Order Routers and Algorithmic trading. It actually makes sense. Better execution represents not only cost savings right now, but a positive
technology improvement that will pay off long term. I hope Celent is right in this assumption.
The past year has clearly demonstrated not only a lack of investment in risk management, but also, as you stated, a reliance on theoretical assumptions to determine portfolio risk management valuations (see the now famous Taleb’s Black Swan book which considers
our thinking to be usually limited in scope and talks to how we make assumptions based on what we see, know, and assume. Reality, however, is actually much more complicated and unpredictable than we think).
The traditionally tight relationship between the hedge funds and their prime brokerage is certainly gone, and therefore they need to disenfranchise themselves by acquiring their own technology. I agree with the fact that the surviving hedge funds, and one
might want to remain sceptical about the doom figure of 75% hedge funds failing, should focus on investing what brings tangible benefits to them. Execution systems, especially in the current multi-asset, multiple broker / alternative execution landscape, requires
at least buy-side smart order routing.
It also seems logical that more people will migrate to trading directly via multi-asset trading systems. This means that the moribund retail online trading will gain market share. This time though, it will come not with an equity bubble, but with investors
which have already gone through multiple bubble / bursts.
We must always remember that technology should be the servant of humans, supporting human decision making, by its ability to analyse large volumes of data very rapidly.
However, the real problems that lead to the credit crunch were to do with the way people think and behave. In addition humans have a highly asymetic way of assessing risk in relation to loss or gain, see Bruce Schenier's fascinating item at
http://www.schneier.com/essay-240.html for an analysis of the topic "Does Risk Management Make Sense?".
Also, the potential rewards were seen to be so high that Risk and Compliance teams were routinely ignored in the lead up to the crunch. But this is a general problem in all fields, not just in the financial institutions.
The crucial issue for senior management today is to ensure that they take better account of the risk analyses and also ensure that the risk analysis is more rigorously and effectively performed.
Adding more technology (at high cost) will achieve nothing if human behaviour is not changed first.
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