Faced with growing pressure on fees, costs and performance, maximising efficiencies across investment operations and implementation functions is more important than ever. Speaking at the recent 8th Fund Summit, a panel of industry experts discussed how investment managers can ‘trim their sails’ to optimise performance.
There’s no doubt that operating conditions have become more challenging, as investment managers navigate COVID-induced market volatility alongside a string of new regulatory measures designed to improve returns to members and optimise efficiency. Chief among those are the recently introduced Your Future Your Super (YFYS) performance test, which compares MySuper product performance against a set of predefined benchmarks; and the upcoming Prudential Standard 226 (CPS 226) on margining and risk mitigation for non-centrally cleared derivatives which – for most investment managers – requires a complete redesign of collateral management practices.
These regulations are far-reaching and concerns of potential unintended consequences are rife, particularly where the YFYS performance test is concerned. However, while the impact on the investment implementation function is significant, panellists also identified opportunities to lift the importance and performance of investment implementation and operations functions.
A common concern is that the YFYS test will trigger a flight to passive, as tracking error and the potential risk of underperformance could leave funds hesitant to diverge from stipulated benchmarks.
Rein van Rooyen, Head of Investment Performance and Operations at QSuper, said that the potential for ‘index-hugging’ could be substantial. “Some of those benchmarks are quite easily replicable, but some aren’t. That creates an interesting dilemma from an investment implementation perspective, as to what extent you can actually replicate those benchmarks and to what extent funds will have the conviction to depart from that benchmark,” van Rooyen said.
He added that it could also cause funds to reconsider portfolio protection strategies, potentially to the detriment of members. “What the performance test potentially does is it punishes you for looking at portfolio protection and overlays because it introduces tracking error compared to those specific benchmarks. The interesting conundrum that boards and management now face is to what extent do you manage business risk, versus managing risks for members?” van Rooyen said.
While these challenges are substantial, there are also opportunities for investment implementation and operations functions – traditionally considered cost-centres – to demonstrate their value-add.
“Efficiencies in implementation and operations go straight to the bottom line of performance and that will garner a lot more attention from the front office,” Gerard Brown, Head of Investment Execution at HESTA said.
Similarly, there are significant advantages to the CPS 226 regime insofar as collateral optimisation can minimise cash drag, risk and free up capital when opportunities arise.
Trimming the sails in practice
Terry Kyle, Country Manager at Financial Risk Solutions said that firms that manage these types of processes well have typically automated processes that are repeatable, with manual operations functions focused on managing exceptions.
“Firms that have ‘trimmed the sails’ if you like, have for the most part implemented software that can automate all of those daily processes that are repeatable, without having human intervention, but they also automate the validation of those processes. [That means] that their operations teams only actually need to look at exceptions in the operations process that need attention,” Kyle said.
“It’s about removing operational risk, while allowing for the expansion of business and not necessarily adding significantly to operations cost,” he said.
The opportunities for automation are myriad, Kyle said. “There are so many opportunities to automate. Things like unit pricing for instance, valuation compliance, cash allocation, re-balancing of investments, report generation, general ledger postings and reconciliations. That could all be ready for you when you come in in the morning,” he said.
At QSuper, van Rooyen has also seen the benefits of paying close attention to “optimal sourcing,” which has come as part of a significant transformation project that has similarly resulted in the automation of previously manual functions.
“Over the last two and a half years we’ve implemented a new strategic data warehouse, alongside a new strategic performance engine, unit pricing and oversight capabilities, as well as cash and instruction solutions [in readiness for CPS 226],” van Rooyen said.
The advantages, he said, have been substantial. “Whereas previously we were able to do one or two deals at any given point in time, now we can do more than 11 deals, simultaneously, at any given point in time. Those are the kind of things that create that efficiency and scale”, van Rooyen said.
HESTA, meanwhile, has been implementing an internalisation programme that has triggered a re-design of the existing operating model, along with a review and uplift of systems. “We’ve looked at building foundations that are both scalable and sustainable as we continue to grow and what we’ve noticed is that in investment execution, we have to work really closely with the investment decision-makers across the fund and that’s from both design or concept phase, right through to implementation and execution,” Brown said, adding that this cooperation proved particularly helpful during the volatile days of March 2020.
“What we’re finding is that investment execution really comes to the fore, because they start to consider all the impacts. They start to look at all the operational risks that are identified and mitigated and help facilitate effective communication – not only across that whole partnership and execution supply chain – but through regular interactions across the wider HESTA investment teams,” Brown said.
Data is critical
Another key component of effective operations and implementation is in the quality of data management.
“You can have the best technology, but if you don’t have good quality data and the ability to integrate it into data models, you’re going to struggle to find the relevant information in a timely manner,” van Rooyen said.
Van Rooyen said that automating trading, exposure management, portfolio and performance data functions proved particularly useful during the early volatile days of COVID-19. “Especially during COVID [having automated these functions proved] quite valuable, in terms of having that information readily available to inform discussions with valuation committees when we needed to consider potential changes,” van Rooyen said.
The importance of data accuracy was also flagged by Kyle. “We know that, leading up to the reporting date for APRA’s performance test, there were more than 60,000 late adjustments to performance data coming in from the industry, to either get greater accuracy over their data or to have a second look over the data. To me that feels a bit like a challenge around systems,” he said.
Kyle said that to address these types of data challenges, oversight of data at-source is critical.
“Whether it be from the third party or whether it be internally, [ensuring] that there’s strong data and there’s accurate data, is absolutely crucial [and] it’s something that can be automated,” Kyle said.
HESTA is also elevating the importance of data as a critical business function.
“We’ve actually worked with the investment management team, we’ve worked across our committees, to explain the benefits and the importance of data and now it comes down to the critical testing of data and understanding its data mastery. The language before used to be ‘security mastering’, we’re now actually talking about data mastering,” Brown said. “It’s making sure that you get data, you validate it once, then you can push it to the downstream decision-making processes.”
That also applies to data management conducted on behalf of third parties. “Going back to March 2020, we looked across the data that was actually required and particularly data from other actors in the industry, whether that was from asset managers or custodians, intra-day liquidity for settlements, securities lending and collateral programmes. What we found was that, as there was heightened stress placed on information, back offices became stressed and capacity limits were hit. The question we’ve got to start to get to as an industry is ‘do we actually start to test the business failure of data when we’re relying on other organisations?” Brown said, adding that HESTA is introducing processes to better understand third party data management.
“It’s about understanding ‘what do our suppliers rely on, do they have spreadsheets, do they have manual processes that we’ve then built processes off the back of?’ Again, we’re really starting to change from that reactive servant in the investment process, to make sure that we can maintain the data, make sure we understand its integrity, the effectiveness and efficiency of its validation as well as the resilience of that delivery right back through the supply chain,” Brown said.