Portfolio risk is a fact of life for the asset manager. While attention has been largely focused on the significant swings in the stock markets following the UK’s Brexit vote, the complex world of fixed income means that returns are regularly impacted by
a wide range of factors. From yield curve sensitivities and reinvestment risk through to underlying credit quality and currency fluctuations, managing a fixed income portfolio is a significant challenge.
As fixed income portfolios and instruments become more complex in nature, this challenge is only growing. Investment banks are increasingly creating bespoke structures for clients which then have to be incorporated into portfolios. While the portfolio
manager can model exposure in bespoke systems, when oversight is requested by a compliance executive or by the chief investment officer, information on complex instruments needs to be provided in an accessible format. This is best achieved through a multi
leg approach, showing the full exposure of each leg and supported by appropriate analytics.
For example, swaps which swap a fixed income for floating income are the most simple of OTC instruments. However, viewing these as a single leg, combining the fixed and floating flows –which can often be valued at close to zero – masks the potentially huge
risk the portfolio is carrying. Splitting the swap into the individual legs and calculating analytics in realtime will appear to all users as instruments that they should be familiar with as they will look like two individual bonds (and show the full exposure
to the individual swap legs). What’s more, this view of the holdings can then be seen by all users of the system.
While many firms still rely on spreadsheets to manage their fixed income portfolios, this approach incurs significant operational risk. Analytics tools that can slice and dice portfolios down to the individual legs of complex instruments and according to
any criteria, from credit quality and duration, through to sector or geographic overlays need to be more widely adopted.
Giving the fund manager control over this data to create the views most useful to their portfolio or security enhances investment decision making, reduces risk and also enables managers to produce tailored reports for compliance and oversight purposes. From
a portfolio view, all the assets need to be covered, including cash, to give a full and accurate representation of a portfolio’s exposure.
Sophisticated modelling tools are now also being used more widely, enabling fund managers to plan for any scenario that might impact their investment returns or cash flow, from early repayments and rate shocks to changes in the shape of the yield curve.
The importance of realtime analytics and portfolio modelling tools in managing a fixed income portfolio supersedes perhaps any other asset class. As we enter another period of market uncertainty, the reliance of fixed income managers on these capabilities
will only grow.