Financial Markets Industry
There are (occaisionally!) some good questions and conversations going on within some of the LinkedIn groups. One recently was around what use cases there are for unstructured data within banking and finance, and I found this comment from Tom Deutsch of IBM to be quite insightful and elegant (at least better than I could I have written it...) on what the main types of unstructured data analysis there are:
- Listening for the first time
- Listening better
- Adding context
Listening for the first time is really just making use of what you already probably capture to hear what is being said (or navigated)
Listening better is making sure you are actually both hearing and understanding what is being said. This is sometimes non-trivial as it involves accuracy issues and true (not marketing hype) NLP technologies and integrating multiple sources of information
Adding context is when you either add structured data to the above or add the above to structured data, usually to round out or more fully inform models (or sometimes just build new ones).
Posted by Brian Sentance | 10 May 2013 | 2:17 pm
I went over to NYU Poly in Brooklyn on Friday of last week for their Big Data Finance Conference. To get a slightly negative point out of the way early, I guess I would have to pose the question "When is a big bata conference, not a big data Conference?". Answer: "When it is a time series analysis conference" (sorry if you were expecting a funny answer...but as you can see, then what I occupy my time with professionally doesn't naturally lend itself to too much comedy). As I like time series analysis, then this was ok, but certainly wasn't fully "as advertised" in my view, but I guess other people are experiencing this problem too.
Maybe this slightly skewed agenda was due to the relative newness of the topic, the newness of the event and the temptation for time series database vendors to jump on the "Big Data" marketing bandwagon (what? I hear you say, we vendors jumping on a buzzword marketing bandwagon, never!...). Many of the talks were about statistical time series analysis of market behaviour and less about what I was hoping for, which was new ways in which empirical or data-based approaches to financial problems might be addressed through big data technologies (as an aside, here is a post on a previous PRMIA event on big data in risk management as some additional background). There were some good attempts at getting a cross-discipline fertilization of ideas going at the conference, but given the topic then representatives from the mobile and social media industries were very obviously missing in my view.
So as a complete counterexample to the two paragraphs above, the first speaker (Kevin Atteson of Morgan Stanley) at the event was on very much on theme with the application of big data technologies to the mortgage market. Apparently Morgan Stanley had started their "big data" analysis of the mortgage market in 2008 as part of a project to assess and understand more about the potential losses than Fannie Mae and Freddie Mac faced due to the financial crisis.
Echoing some earlier background I had heard on mortgages, one of the biggest problems in trying to understand the market according to Kevin was data, or rather the lack of it. He compared mortgage data analysis to "peeling an onion" and that going back to the time of the crisis, mortgage data at an individual loan level was either not available or of such poor quality as to be virtually useless (e.g. hard to get accurate ZIP code data for each loan). Kevin described the mortgage data set as "wide" (lots of loans with lots of fields for each loan) rather than "deep" (lots of history), with one of the main data problems was trying to match nearest-neighbour loans. He mentioned that only post crisis have Fannie and Freddie been ordered to make individual loan data available, and that there is still no readily available linkage data between individual loans and mortgage pools (some presentations from a recent PRMIA event on mortgage analytics are at the bottom of the page here for interested readers).
Kevin said that Morgan Stanley had rejected the use of Hadoop, primarily due write through-put capabilities, which Kevin indicated was a limitating factor in many big data technologies. He indicated that for his problem type that he still believed their infrastructure to be superior to even the latest incarnations of Hadoop. He also mentioned the technique of having 2x redundancy or more on the data/jobs being processed, aimed not just at failover but also at using the whichever instance of a job that finished first. Interestingly, he also added that Morgan Stanley's infrastructure engineers have a policy of rebooting servers in the grid even during the day/use, so fault tolerance was needed for both unexpected and entirely deliberate hardware node unavailability.
Other highlights from the day:
- Dennis Shasha had some interesting ideas on using matrix algebra for reducing down the data analysis workload needed in some problems - basically he was all for "cleverness" over simply throwing compute power at some data problems. On a humourous note (if you are not a trader?), he also suggested that some traders had "the memory of a fruit-fly".
- Robert Almgren of QuantitativeBrokers was an interesting speaker, talking about how his firm had done a lot of analytical work in trying to characterise possible market responses to information anouncements (such as Friday's non-farm payroll announcement). I think Robert was not so much trying to predict the information itself, but rather trying to predict likely market behaviour once the information is announced.
- Scott O'Malia of the CFTC was an interesting speaker during the morning panel. He again acknowledged some of the recent problems the CFTC had experienced in terms of aggregating/analysing the data they are now receiving from the market. I thought his comment on the twitter crash was both funny and brutally pragmatic with him saying "if you want to rely solely upon a single twitter feed to trade then go ahead, knock yourself out."
- Eric Vanden Eijnden gave an interesting talk on "detecting Black Swans in Big Data". Most of the examples were from current detection/movement in oceanography, but seemed quite analogous to "regime shifts" in the statistical behaviour of markets. Main point seemed to be that these seemingly unpredicatable and infrequent events were predictable to some degree if you looked deep enough in the data, and in particular that you could detect when the system was on a possible likely "path" to a Black Swan event.
One of the most interesting talks was by Johan Walden of the Haas Business School, on the subject of "Investor Networks in the Stock Market". Johan explained how they had used big data to construct a network model of all of the participants in the Turkish stock exchange (both institutional and retail) and in particular how "interconnected" each participant was with other members. His findings seemed to support the hypothesis that the more "interconnected" the investor (at the centre of many information flows rather than add the edges) the more likely that investor would demonstrate superior return levels to the average. I guess this is a kind of classic transferral of some of the research done in social networking, but very interesting to see it applied pragmatically to financial markets, and I would guess an area where a much greater understanding of investor behaviour could be gleaned. Maybe Johan could do with a little geographic location data to add to his analysis of how information flows.
So overall a good day with some interesting talks - the statistical presentations were challenging to listen to at 4pm on a Friday afternoon but the wine afterwards compensated. I would also recommend taking a read through a paper by Charles S. Tapiero on "The Future of Financial Engineering" for one of the best discussions I have so far read about how big data has the potential to change and improve upon some of the assumptions and models that underpin modern financial theory (haven't found an online copy as yet but will update when I do). Coming back to my starting point in this post on the content of the talks, I liked the description that Charles gives of traditional "statistical" versus "data analytics" approaches, and some of the points he makes about data immediately inferring relationships without the traditional "hypothesize, measure, test and confirm-or-not" were interesting, both in favour of data analytics and in cautioning against unquestioning belief in the findings from data (feels like this post from October 2008 is a timely reminder here). With all of the hype and the hope around the benefits of big data, maybe we would all be wise to remember this quote by a certain well-known physicist: "No amount of experimentation can ever prove me right; a single experiment can prove me wrong."
Posted by Brian Sentance | 7 May 2013 | 4:26 pm
Today is the last day of voting in the FTF News Technology Innovation Awards 2013. Our TimeScape solution has been nominated under the Best Enterprise Data Management (EDM) category. If you can spare a minute of your time today, then Xenomorph would very much appreciate your vote!
Posted by Brian Sentance | 30 April 2013 | 2:37 pm
Background - I went along to my first PRMIA event in Stamford, CT last night, with the rather grandiose title of "The Anthropology, Sociology, and Epistemology of Risk". Stamford is about 30 miles north of Manhattan and is the home to major offices of a number of financial markets companies such as Thomson Reuters, RBS and UBS (who apparently have the largest column-less trading floor in the world at their Stamford headquarters - particularly useful piece of trivia for you there...). It also happens to be about 5 minutes drive/train journey away from where I now live, so easy for me to get to (thanks for another useful piece of information I hear you say...). Enough background, more on the event which was a good one with five risk managers involved in an interesting and sometimes philosophical discussion on fundamentally what "risk management" is all about.
Introduction - Marc Groz who heads the Stamford Chapter of PRMIA introduced the evening and started by thanking Barry Schwimmer for allowing PRMIA to use the Stamford Innovation Centre (the Old Town Hall) for the meeting. Henrik Neuhaus moderated the panel, and started by outlining the main elements of the event title as a framework for the discussion:
- Anthropology - risk management is to what purpose?
- Sociology - how does risk management work?
- Epistemology - what knowledge is really contained within risk management?
Henrik started by taking a passage about anthropology and replacing human "development" with "risk management" which seemed to fit ok, although the angle I was expecting was much more about human behaviour in risk management than where Henrik started. Henrik asked the panel what results they had seen from risk management and what did that imply about risk management? The panelists seemed a little confused or daunted by the question prompting one of them to ask "Is that the question?".
Business Model and Risk Culture - Elliot Noma dived in by responding that the purpose of risk management obviously depended very much on what are the institutional goals of the organization. He said that it was as much about what you are forced to do and what you try to do in risk management. Elliot said that the sell-side view of risk management was very regulatory and capital focused, whereas mutual funds are looking more at risk relative to benchmarks and performance attribution. He add that in the alternatives (hedge-fund) space then there were no benchmarks and the focus was more about liquidity and event risk.
Steve Greiner said that it was down to the investment philosophy and how risk is defined and measured. He praised some asset managers where the risk managers sit across from the portfolio managers and are very much involved in the decision making process.
Henrik asked the panel whether any of the panel had ever defined a “mission statement” for risk management. Marc Groz chipped in that he remember that he had once defined one, and that it was very different from what others in the institution were expecting and indeed very different from the risk management that he and his department subsequently undertook.
Mark Szycher (of GM Pension Fund) said that risk management split into two areas for him, the first being the symmetrical risks where you need to work out the range of scenarios for a particular trade or decision being taken. The second was the more asymmetrical risks (i.e. downside only) such as those found in operational risk where you are focused on how best to avoid them happening.
Micro Risk Done Well - Santa Federico said that he had experience of some of the major problems experienced at institutions such as Merrill Lynch, Salomen Brothers and MF Global, and that he thought risk management was much more of a cultural problem than a technical one. Santa said he thought that the industry was actually quite good at the micro (trade, portfolio) risk management level, but obviously less effective at the large systematic/economic level. Mark asked Santa what was the nature of the failures he had experienced. Santa said that the risks were well modeled, but maybe the assumptions around macro variables such as the housing market proved to be extremely poor.
Keep Dancing? - Henrik asked the panel what might be done better? Elliot made the point that some risks are just in the nature of the business. If a risk manager did not like placing a complex illiquid trade and the institution was based around trading in illiquid markets then what is a risk manager to do? He quote the Citi executive who said “ whilst the music is still playing we have to dance”. Again he came back to the point that the business model of the institution drives its cultural and the emphasis of risk management (I guess I see what Elliot was saying but taken one way it implied that regardless of what was going on risk management needs to fit in with it, whereas I am sure that he meant that risk managers must fit in with the business model mandated to shareholders).
Risk Attitudes in the USA - Mark said that risk managers need to recognize that the improbable is maybe not so improbable and should be more prepared for the worst rather than risk management under “normal” market and institutional behavior. Steven thought that a cultural shift was happening, where not losing money was becoming as important to an organization as gaining money. He said that in his view, Europe and Asia had a stronger risk culture than in the United States, with much more consensus, involvement and even control over the trading decisions taken. Put another way, the USA has more of a culture of risk taking than Europe. (I have my own theories on this. Firstly I think that the people are generally much more risk takers in the USA than in UK/Europe, possibly influenced in part by the relative lack of underlying social safety net – whilst this is not for everyone, I think it produces a very dynamic economy as a result. Secondly, I do not think that cultural desire in the USA for the much admired “presidential” leader necessarily is the best environment for sound, consensus based risk management. I would also like to acknowledge that neither of my two points above seem to have protected Europe much from the worst of the financial crisis, so it is obviously a complex issue!).
Slaves to Data? - Henrik asked whether the panel thought that risk managers were slaves to data? He expanded upon this by asking what kinds of firms encourage qualitative risk management and not just risk management based on Excel spreadsheets? Santa said that this kind of qualitative risk management occurred at a business level and less so at a firm wide level. In particular he thought this kind of culture was in place at many hedge funds, and less so at banks. He cited one example from his banking career in the 1980's, where his immediate boss was shouted off the trading floor by the head of desk, saying that he should never enter the trading floor again (oh those were the days...).
Sociology and Credibility - Henrik took a passage on the historic development of women's rights and replaced the word "women" with "risk management" to illustrate the challenges risk management is facing with trying to get more say and involvement at financial institutions. He asked who should the CRO report to? A CEO? A CIO? Or a board member? Elliot responded by saying this was really a issue around credibility with the business for risk managers and risk management in general. He made the point that often Excel and numbers were used to establish credibility with the business. Elliot added that risk managers with trading experience obviously had more credibility, and to some extent where the CRO reported to was dependent upon the credibility of risk management with the business.
Trading and Risk Management Mindsets - Elliot expanded on his previous point by saying that the risk management mindset thinks more in terms of unconditional distributions and tries to learn from history. He contrasted this with a the "conditional mindset' of a trader, where the time horizon forwards (and backwards) is rarely longer than a few days and the belief is strong that a trade will work today given it worked yesterday is high. Elliot added that in assisting the trader, the biggest contribution risk managers can make is more to be challenging/helpful on the qualitative side rather than just quantitative.
Compensation and Transactions - Most of the panel seemed to agree that compensation package structure was a huge influencer in the risk culture of an organisation. Mark touched upon a pet topic of mine, which is that it very hard for a risk manager to gain credibility (and compensation) when what risk management is about is what could happen as opposed to what did happen. A risk manager blocking a trade due to some potentially very damaging outcomes will not gain any credibility with the business if the trading outcome for the suggested trade just happened to come out positive. There seemed to be concensus here that some of the traditional compensation models that were based on short-term transactional frequency and size were ill-formed (given the limited downside for the individual), and whilst the panel reserved judgement on the effectiveness of recent regulation moves towards longer-term compensation were to be welcome from a risk perspective.
MF Global and Busines Models - Santa described some of his experiences at MF Global, where Corzine moved what was essentially a broker into taking positions in European Sovereign Bonds. Santa said that the risk management culture and capabilities were not present to be robust against senior management for such a business model move. Elliot mentioned that he had been courted for trades by MF Global and had been concerned that they did not offer electronic execution and told him that doing trades through a human was always best. Mark said that in the area of pension fund management there was much greater fidiciary responsibility (i.e. behave badly and you will go to jail) and maybe that kind of responsibility had more of a place in financial markets too. Coming back to the question of who a CRO should report to, Mark also said that questions should be asked to seek out those who are 1) less likely to suffer from the "agency" problem of conflicts of interest and on a related note those who are 2) less likely to have personal biases towards particular behaviours or decisions.
Santa said that in his opinion hedge funds in general had a better culture where risk management opinions were heard and advice taken. Mark said that risk managers who could get the business to accept moral persuasion were in a much stronger position to add value to the business rather than simply being able to "block" particular trades. Elliot cited one experience he had where the traders under his watch noticed that a particular type of trade (basis trades) did not increase their reported risk levels, and so became more focussed on gaming the risk controls to achieve high returns without (reported) risk. The panel seemed to be in general agreement that risk managers with trading experience were more credible with the business but also more aware of the trader mindset and behaviors.
Do we know what we know? - Henrik moved to his third and final subsection of the evening, asking the panel whether risk managers really know what they think they know. Elliot said that traders and risk managers speak a different language, with traders living in the now, thinking only of the implications of possible events such as those we have seen with Cyprus or the fiscal cliff, where the risk management view was much less conditioned and more historical. Steven re-emphasised the earlier point that risk management at this micro trading level was fine but this was not what caused events such as the collapse of MF Global.
Rational argument isn't communication - Santa said that most risk managers come from a quant (physics, maths, engineering) background and like structured arguments based upon well understood rational foundations. He said that this way of thinking was alien to many traders and as such it was a communication challenge for risk managers to explain things in a way that traders would actually put some time to considering. On the modelling side of things, Santa said that sometimes traders dismissed models as being "too quant" and sometimes traders followed models all too blindly without questioning or understanding the simplifying assumptions they are based on. Santa summarised by saying that risk management needs to intuitive for traders and not just academically based. Mark added that a quantitative focus can sometimes become too narrow (modeler's manifesto anyone?) and made the very profound point that unfortunately precision often wins over relevance in the creation and use of many models. Steven added that traders often deal with absolutes, so as knowing the spread between two bonds to the nearest basis point, whereas a risk manager approaching them with a VaR number really means that this is the estimated VaR which really should be thought to be within a range of values. This is alien to the way traders think and hence harder to explain.
Unanticipated Risk - An audience member asked whether risk management should focus mainly on unanticipated risks rather than "normal' risks. Elliot said that in his trading he was always thinking and checking whether the markets were changing or continuing with their recent near-term behaviour patterns. Steven said that history was useful to risk management when markets were "normal", but in times of regime shifts this was not the case and cited the example of the change in markets when Mario Dragi announced that the ECB would stand behind the Euro and its member nations.
Risky Achievements - Henrik closed the panel by asking each member what they thought was there own greatest achievement in risk management. Elliot cited a time when he identified that a particular hedge fund had a relatively inconspicuous position/trade that he identified as potentially extremely dangerous and was proved correct when the fund closed down due to this. Steven said he was proud of some good work he and his team did on stress testing involving Greek bonds and Eurozone. Santa said that some of the work he had done on portfolio "risk overlays" was good. Mark ended the panel by saying that he thought his biggest achievement was when the traders and portfolio managers started to come to the risk management department to ask opinions before placing key trades. Henrik and the audience thanked the panel for their input and time.
An Insured View - After the panel closed I spoke with an actuary who said that he had greatly enjoyed the panel discussions but was surprised that when talking of how best to support the risk management function in being independent and giving "bad" news to the business, the role of auditors were not mentioned. He said he felt that auditors were a key support to insurers in ensuring any issues were allowed to come to light. So food for thought there as to whether financial markets can learn from other industry sectors.
Summary - great evening of discussion, only downside being the absence of wine once the panel had closed!
Posted by Brian Sentance | 25 April 2013 | 9:26 pm
Katherine Moriaty was a very interesting speaker at the ETF event, and she talked us through some of the regulatory issues in relation to ETFs, particularly in relation to non-transparent ETFs. Katherine provided some history on the regulation of the fund industry in the US, particularly in relation to the Investment Company Act of 1940 which was enacted to restore public confidence in the fund management industry following the troubled times of the late 1920's and through the 1930's.
The fundamental concern for the SEC (the regulatory body for this) is that the provider of the fund products cannot game investors, providing false or incorrect valuations to maximize profits. Based on the "'40 Act" as she termed it, the SEC has allowed exemptions to allow various index and fund products, such as for smart indices you need full disclosure of the rules involved, plus with active indices then constituents are published. However with active ETFs, retail investors are at a disadvantage to authorized participants (APs, the ETF providers) since there is no transparency around the constituents.
Obviously fund managers want to manage portfolios without disclosure (to maintain the "secrets" of their success, to keep trading costs low etc), but no solution has yet been found to allow this for ETFs that satisfies the SEC that the small guy is not at risk from this lack of transparency. Katherine said that participants were still still trying to come up with solutions to this problem and the SEC is still open to an exemption for anything that in their view, "works" (sounds like someone will make a lot of money when/if a solution is found). Solutions tried so far include using blind trusts and proxy or shadow portfolios. Someone from the audience asked about the relative merits of Active ETFs when compared to Active Mutual Funds - Katherine answered that the APs wanted an exchange traded product as a new distribution channel (and I guess us "Joe Soaps" want lower fees for active management...)
Vikas Kalra of MSCI had the uneviable position of giving the last presentation of the evening, and he said he would keep his talk short since he was aware he was standing between us and the cocktail reception to follow. Vikas described the problem that many risk managers faced, which was that doing risk management for a portfolio containing ETFs was fine when the ETF was of a "look through" type (i.e. constituents available), but when the ETF is opaque (no/little/uncertain constituent data) then the choices were usually 1) remove the ETF from the risk calculation or 2) substitute some proxy instrument.
Vikas said the Barra part of MSCI had come up with the solution to analyse ETF "styles". From what I could tell, this looked like some sophisticated form of 2) above, where Barra had done the analysis to enable an opaque ETF to be replaced by some more transparent proxy which allowed constituents to be analysed within the risk process and correlations etc recognised. Vikas said that 400 ETFs and ETNs were now covered in their product offering.
Conclusion - Overall a very interesting event that improved my knowledge of ETFs and had some great speakers.
Posted by Brian Sentance | 23 April 2013 | 11:26 pm
Joanne Hill of Proshare presented next at the event. Joanne started her talk by illustrating how showing volatility levels from 1900 to the present day, and how historic volatility over the past 10 years seems to be at pre-1950's levels. Joanne had a lot of slides that she took us through (to be available on the event link above) which would be challenging to write up everyone (or at least that is my excuse and I am sticking to it...).
Joanne said that the VIX trades about 4% above realised volatility, which she described as being due to expectations that "something" might happen (so financial markets can be cautious it seems!). Joanne seemed almost disappointed that we seem now to have entered a period of relatively boring (?!) market activity following the end of the crisis given that the VIX is now trading at pre-2007 lows. In answer to audience questions she said that inverse volatility indices were growing as were products dependent on dynamic index strategies.
Posted by Brian Sentance | 23 April 2013 | 10:12 pm
Next up in the event was Phil Mackintosh of Credit Suisse who gave his presentation on trading ETFs, starting with some scene-setting for the market. Phil said that the ETP market had expanded enormously since its start in 1993, currently with over $2trillion of assets ($1.3trillion in the US). He mentioned that $1 in $4 of flow in the US was ETF related, and that the US ETF market was larger than the whole of the Asian equity market, but again emphasizing relative size the US ETF market was much smaller than the US equities and futures markets.
He said that counter to the impression some have, the market is 52% institutional and only 48% retail. He mentioned that some macro hedge fund managers he speaks to manage all their business through ETPs. ETFs are available across all asset classes from alternatives, currencies, commodities, fixed income, international and domestic equities. Looking at fees, these tend to reside in the 0.1% to 1% bracket, with larger fees charged only for products that have specific characteristics and/or that are difficult to replicate.
Phil illustrated how funds have consistently flowed into ETFs over recent years, in contrast with the mutual funds industry, with around 25% in international equity and around 30% in fixed income. He said that corporate fixed income, low volatility equity indices and real estate ETFs were all on the up in terms of funds flow.
He said that ETF values were calculated every 15 seconds and oscillated around there NAV, with arbitrage activity keeping ETF prices in line with underlying prices. Phil said that spreads in ETFs could be tighter than in their underlyings and that ETF spreads tightened for ETFs over $200m.
Phil warned of a few traps in trading ETFs. He illustrated the trading volumes of ETFs during an average which showed that they tended to be traded in volume in the morning but not (late) afternoon (need enlightening as to why..). He added that they were more specifically not a trade for a market open or close. He said that large ETF trades sometimes caused NAV disconnects, and mentioned deviations around NAV due to underlying liquidity levels. He also said that contango can become a problem for VIX futures related products.
There were a few audience questions. One concerned how fixed income ETFs were the price discovery mechanism for some assets during the crisis given the liquidity and timeliness of the ETF relative to its underlyings. Another question concerned why the US ETF market was larger and more homogenous then in Europe. Phil said that Europe was not dominated by 3 providers as in the US, plus each nationality in Europe tended to have preferences for ETF products produced by each country. This was also further discussions on shorting Fixed Income ETFs since they were more liquid than the primary market. (Inote to self, need to find out more about the details of the ETF redemption and creation process).
Overall a great talk by a very "sharp" presenter (like a lot of good traders Phil seemed to understand the relationships in the market without needing to think about them too heavily).
Posted by Brian Sentance | 23 April 2013 | 9:52 pm
It seems to be ETF week for events in New York this week, one of which was hosted by PRMIA, Credit Suisse and MSCI last night called "Risk Management of and with ETFs/Indices". The event was chaired by Seddik Meziani of Montclair State University, who opened with thanks for the sponsors and the speakers for coming along, and described the great variety of asset exposures now available in Exchange Traded Products (ETPs) and the growth in ETF assets since their formation in 1993. He also mentioned that this was the first PRMIA event in NYC specifically on ETFs.
Index-Based Approaches for Risk Management in Wealth Management - Shaun Weuzbach of S&P Dow Jones Indices started with his proesentation. Shaun's initial point was to consider whether "Buy & Hold" works given the bad press it received over the crisis. Shaun said that the peak to trough US equity loss during the recent crisis was 57%, but when he hears of investors that made losses of this order he thinks that this was more down to a lack of diversification and poor risk management rather than inherent failures in buy and hold. To justify this, he sited an example simple portfolio constructed of 60% equity and 40% fixed income, which only lost 13% peak to trough during the crisis. He also illustrated that equity market losses of 5% or more were far more frequent during the period 1945-2012 than many people imagine, and that investors should be aware of this in portfolio construction.
Shaun suggested that we are in the third innings of indexing:
- Broad-based benchmark indices
- Precise sector-and thematic-based indices
- Factor-based indices (involving active strategies)
Where the factor-based indices might include ETF strategies based on/correlated with things such as dividend payments, equity weightings, fundamentals, revenues, GDP weights and volatility.
He then described how a simple strategy index based around lowering volatility could work. Shaun suggested that low volatility was easier to explain than minimizing variance to retail investors. The process for his example low volatility index was take the 100 lowest volatility stocks out of the the S&P500 and weight by the inverse of volatility, with rebalancing every quarter.
He illustrated how this index exhibited lower volatility with higher returns over the past 13 years or so (this looked like a practical example illustrating some of the advantages of having a less volatile geometric mean of returns from what I could see). He also said that this index had worked across both developed and emerging markets.
Apparently this index has been available for only 2 years, so 11 years of the performance figures were generated from back-testing (the figures looked good, but a strategy theoretically backtested over historic markets when the strategy was not used and did not exist should always be examined sceptically).
Looking at the sector composition of this low volatility index, then one of the very interesting points that Shaun made was that the index got of the financials sector some two quarters before Lehman's went down (maybe the index was less influenced by groupthink or the fear of realising losses?)
Shaun then progressed to look a short look at VIX-based strategies, describing the VIX as the "investor fear guage". In particular he considered the S&P VIX Short-Term Future Index, which he said exhibits a high negative correlation with the S&P500 (around -0.8) and a high positive correlation with the VIX spot (approx +0.8). He said that explaining these products as portfolio insurance products was sometimes hard for financial advisors to do, and features such as the "roll cost" (moving from one set of futures contracts to others as some expire) was also harder to explain to non-institutional investors.
A few audience questions followed, one concerned concerned with whether one could capture principal retention in fixed income ETFs. Shaun briefly mentioned that the audience member should look at "maturity series" products in the ETP market. One audience member had concerns over the liquidity of ETF underlyings, to which Shaun said that S&P have very strict criteria for their indices ensuring that the free float of underlyings is high and that the ETF does not dominate liquidity in the underlying market.
Overall a very good presentation from a knowledgeable speaker.
Posted by Brian Sentance | 23 April 2013 | 7:30 pm
Xenomorph has been short-listed in the FTF News Technology Innovation Awards 2013, under the Best Enterprise Data Management (EDM) category. The short-list includes:
BEST ENTERPRISE DATA MANAGEMENT SOLUTION
- Eagle Investment Systems – Eagle Data Management
- GoldenSource – GoldenSource EDM
- Markit - Markit EDM
- SmartStream/Euroclear Partnership
- Xenomorph - TimeScape
If you can spare a few moments of your time, then Xenomorph would very much appreciate your vote!
Posted by Brian Sentance | 10 April 2013 | 7:23 pm
In these times of disfunctional political parties, external troikas and technocratic governments, why not exercise your democratic rights in a positive way by voting for Xenomorph in the best Enterprise Data Management category of the Inside Reference Data Awards 2013. You know it makes democratic sense.
Posted by Brian Sentance | 5 April 2013 | 12:26 pm
Just caught saw a reference on LinkedIn to this FT article "Finance groups lack spreadsheet controls". Started to write a quick response and given it is one of my major hobby-horses, I ended up doing a bit of an essay, so I decided to post it here too:
"As many people have pointed out elsewhere, much of the problem with spreadsheet usage is that they are not treated as a corporate and IT asset, and as such things like testing, peer review and general QA are not applied (mind you, maybe more of that should still be applied to many mainstream software systems in financial markets...).
Ralph and the guys at Cluster Seven do a great job in helping institutions to manage and monitor spreadsheet usage (I like Ralph's "we are CCTV for spreadsheets" analogy), but I think a fundamental (and often overlooked) consideration is to ask yourself why did the business users involved decide that they needed spreadsheets to manage trading and risk in the first place? It is a bit like trying to address the symptoms of a illness without ever considering how we got the illness in the first place.
Excel is a great tool, but to quote Spider-Man "with great power comes great responsibility" and I guess we can all see the consequences of not taking the usage of spreadsheets seriously and responsibly. So next time the trader or risk manager says "we've just built this really great model in Excel" ask them why they built it in Excel, and why they didn't build upon the existing corporate IT solutions and tools. In these cost- and risk- conscious times, I think the answers would be interesting..."
Posted by Brian Sentance | 27 March 2013 | 11:09 am
Very pleased to announce today that Mediobanca, the leading investment bank in Italy, has decided to select TimeScape as its data management system. You can see the press release here.
Posted by Brian Sentance | 25 March 2013 | 12:58 pm
Thanks to one of my PRMIA colleagues for pointing out this article in the WSJ, talking about how regulatory driven stress testing in the US is promoting conformity and reducing innovation in approach to risk management. Echos some posts from last year on regulation increasing risk and diversity of regulation.
Posted by Brian Sentance | 20 March 2013 | 3:18 pm
Notes I took from a recent Oliver Wyman sponsored PRMIA event in New York, who brought together a panel of senior managers and CROs from leading asset management organizations to discuss the role of risk management for asset managers, specifically the types of governance and controls necessary to safeguard client's assets in the current macro environment. You can access the notes here on the PRMIA site.
Posted by Brian Sentance | 14 March 2013 | 11:23 am
A little late on these notes from this PRMIA Event on Big Data in Risk Management that I helped to organize last month at the Harmonie Club in New York. Big thank you to my PRMIA colleagues for taking the notes and for helping me pull this write-up together, plus thanks to Microsoft and all who helped out on the night.
Introduction: Navin Sharma (of Western Asset Management and Co-Regional Director of PRMIA NYC) introduced the event and began by thanking Microsoft for its support in sponsoring the evening. Navin outlined how he thought the advent of “Big Data” technologies was very exciting for risk management, opening up opportunities to address risk and regulatory problems that previously might have been considered out of reach.
Navin defined Big Data as the structured or unstructured in receive at high volumes and requiring very large data storage. Its characteristics include a high velocity of record creation, extreme volumes, a wide variety of data formats, variable latencies, and complexity of data types. Additionally, he noted that relative to other industries, in the past financial services has created perhaps the largest historical sets of data and continually creates enormous amount of data on a daily or moment-by-moment basis. Examples include options data, high frequency trading, and unstructured data such as via social media. Its usage provides potential competitive advantages in a trading and investment management. Also, by using Big Data it is possible to have faster and more accurate recognition of potential risks via seemingly disparate data - leading to timelier and more complete risk management of investments and firms’ assets. Finally, the use of Big Data technologies is in part being driven by regulatory pressures from Dodd-Frank, Basel III, Solvency II, Markets for Financial Instruments Directives (1 & 2) as well as Markets for Financial Instruments Regulation.
Navin also noted that we will seek to answer questions such as:
- What is the impact of big data on asset management?
- How can Big Data’s impact enhance risk management?
- How is big data used to enhance operational risk?
Presentation 1: Big Data: What Is It and Where Did It Come From?: The first presentation was given by Michael Di Stefano (of Blinksis Technologies), and was titled “Big Data. What is it and where did it come from?”. You can find a copy of Michael’s presentation here. In summary Michael started with saying that there are many definitions of Big Data, mainly defined as technology that deals with data problems that are either too large, too fast or too complex for conventional database technology. Michael briefly touched upon the many different technologies within Big Data such as Hadoop, MapReduce and databases such as Cassandra and MongoDB etc. He described some of the origins of Big Data technology in internet search, social networks and other fields. Michael described the “4 V’s” of Big Data: Volume, Velocity, Variety and a key point from Michael was “time to Value” in terms of what you are using Big Data for. Michael concluded his talk with some business examples around use of sentiment analysis in financial markets and the application of Big Data to real-time trading surveillance.
Presentation 2: Big Data Strategies for Risk Management: The second presentation “Big Data Strategies for Risk Management” was introduced by Colleen Healy of Microsoft (presentation here). Colleen started by saying expectations of risk management are rising, and that prior to 2008 not many institutions had a good handle on the risks they were taking. Risk analysis needs to be done across multiple asset types, more frequently and at ever greater granularity. Pressure is coming from everywhere including company boards, regulators, shareholders, customers, counterparties and society in general. Colleen used to head investor relations at Microsoft and put forward a number of points:
- A long line of sight of one risk factor does not mean that we have a line of sight on other risks around.
- Good risk management should be based on simple questions.
- Reliance on 3rd parties for understanding risk should be minimized.
- Understand not just the asset, but also at the correlated asset level.
- The world is full of fast markets driving even more need for risk control
- Intraday and real-time risk now becoming necessary for line of sight and dealing with the regulators
- Now need to look at risk management at a most granular level.
Colleen explained some of the reasons why good risk management remains a work in progress, and that data is a key foundation for better risk management. However data has been hard to access, analyze, visualize and understand, and used this to link to the next part of the presentation by Denny Yu of Numerix.
Denny explained that new regulations involving measures such as Potential Future Exposure (PFE) and Credit Value Adjustment (CVA) were moving the number of calculations needed in risk management to a level well above that required by methodologies such as Value at Risk (VaR). Denny illustrated how the a typical VaR calculation on a reasonable sized portfolio might need 2,500,000 instrument valuations and how PFE might require as many as 2,000,000,000. He then explain more of the architecture he would see as optimal for such a process and illustrated some of the analysis he had done using Excel spreadsheets linked to Microsoft’s high performance computing technology.
Presentation 3: Big Data in Practice: Unintentional Portfolio Risk: Kevin Chen of Opera Solutions gave the third presentation, titled “Unintentional Risk via Large-Scale Risk Clustering”. You can find a copy of the presentation here. In summary, the presentation was quite visual and illustrating how large-scale empirical analysis of portfolio data could produce some interesting insights into portfolio risk and how risks become “clustered”. In many ways the analysis was reminiscent of an empirical form of principal component analysis i.e. where you can see and understand more about your portfolio’s risk without actually being able to relate the main factors directly to any traditional factor analysis.
Panel Discussion: Brian Sentance of Xenomorph and the PRMIA NYC Steering Committee then moderated a panel discussion. The first question was directed at Michael “Is the relational database dead?” – Michael replied that in his view relational databases were not dead and indeed for dealing with problems well-suited to relational representation were still and would continue to be very good. Michael said that NoSQL/Big Data technologies were complimentary to relational databases, dealing with new types of data and new sizes of problem that relational databases are not well designed for. Brian asked Michael whether the advent of these new database technologies would drive the relational database vendors to extend the capabilities and performance of their offerings? Michael replied that he thought this was highly likely but only time would tell whether this approach will be successful given the innovation in the market at the moment. Colleen Healy added that the advent of Big Data did not mean the throwing out of established technology, but rather an integration of established technology with the new such as with Microsoft SQL Server working with the Hadoop framework.
Brian asked the panel whether they thought visualization would make a big impact within Big Data? Ken Akoundi said that the front end applications used to make the data/analysis more useful will evolve very quickly. Brian asked whether this would be reminiscent of the days when VaR first appeared, when a single number arguably became a false proxy for risk measurement and management? Ken replied that the size of the data problem had increased massively from when VaR was first used in 1994, and that visualization and other automated techniques were very much needed if the headache of capturing, cleansing and understanding data was to be addressed.
Brian asked whether Big Data would address the data integration issue of siloed trading systems? Colleen replied that Big Data needs to work across all the silos found in many financial organizations, or it isn’t “Big Data”. There was general consensus from the panel that legacy systems and people politics were also behind some of the issues found in addressing the data silo issue.
Brian asked if the panel thought the skills needed in risk management would change due to Big Data? Colleen replied that effective Big Data solutions require all kinds of people, with skills across a broad range of specific disciplines such as visualization. Generally the panel thought that data and data analysis would play an increasingly important part for risk management. Ken put forward his view all Big Data problems should start with a business problem, with not just a technology focus. For example are there any better ways to predict stock market movements based on the consumption of larger and more diverse sources of information. In terms of risk management skills, Denny said that risk management of 15 years ago was based on relatively simply econometrics. Fast forward to today, and risk calculations such as CVA are statistically and computationally very heavy, and trading is increasingly automated across all asset classes. As a result, Denny suggested that even the PRMIA PRM syllabus should change to focus more on data and data technology given the importance of data to risk management.
Asked how best to should Big Data be applied?, then Denny replied that echoed Ken in saying that understanding the business problem first was vital, but that obviously Big Data opened up the capability to aggregate and work with larger datasets than ever before. Brian then asked what advice would the panel give to risk managers faced with an IT department about to embark upon using Big Data technologies? Assuming that the business problem is well understood, then Michael said that the business needed some familiarity with the broad concepts of Big Data, what it can and cannot do and how it fits with more mainstream technologies. Colleen said that there are some problems that only Big Data can solve, so understanding the technical need is a first checkpoint. Obviously IT people like working with new technologies and this needs to be monitored, but so long as the business problem is defined and valid for Big Data, people should be encouraged to learn new technologies and new skills. Kevin also took a very positive view that IT departments should be encouraged to experiment with these new technologies and understand what is possible, but that projects should have well-defined assessment/cut-off points as with any good project management to decide if the project is progressing well. Ken put forward that many IT staff were new to the scale of the problems being addressed with Big Data, and that his own company Opera Solutions had an advantage in its deep expertise of large-scale data integration to deliver quicker on project timelines.
Audience Questions: There then followed a number of audience questions. The first few related to other ideas/kinds of problems that could be analyzed using the kind of modeling that Opera had demonstrated. Ken said that there were obvious extensions that Opera had not got around to doing just yet. One audience member asked how well could all the Big Data analysis be aggregated/presented to make it understandable and usable to humans? Denny suggested that it was vital that such analysis was made accessible to the user, and there general consensus across the panel that man vs. machine was an interesting issue to develop in considering what is possible with Big Data. The next audience question was around whether all of this data analysis was affordable from a practical point of view. Brian pointed out that there was a lot of waste in current practices in the industry, with wasteful duplication of ticker plants and other data types across many financial institutions, large and small. This duplication is driven primarily by the perceived need to implement each institution’s proprietary analysis techniques, and that this kind of customization was not yet available from the major data vendors, but will become more possible as cloud technology such as Microsoft’s Azure develops further. There was a lot of audience interest in whether Big Data could lead to better understanding of causal relationships in markets rather than simply correlations. The panel responded that causal relationships were harder to understand, particularly in a dynamic market with dynamic relationships, but that insight into correlation was at the very least useful and could lead to better understanding of the drivers as more datasets are analyzed.
Posted by Brian Sentance | 14 February 2013 | 10:26 pm
Good post from Jim Jockle over at Numerix - main theme is around having an "analytics" strategy in place in addition to (and probably as part of) a "Big Data" strategy. Fits strongly around Xenomorph's ideas on having both data management and analytics management in place (a few posts on this in the past, try this one from a few years back) - analytics generate the most valuable data of all, yet the data generated by analytics and the input data that supports analytics is largely ignored as being too business focussed for many data management vendors to deal with, and too low level for many of the risk management system vendors to deal with. Into this gap in functionality falls the risk manager (supported by many spreadsheets!), who has to spend too much time organizing and validating data, and too little time on risk management itself.
Within risk management, I think it comes down to having the appropriate technical layers in place of data management, analytics/pricing management and risk model management. Ok it is a greatly simplified representation of the architecture needed (apologies to any techies reading this), but the majority of financial institutions do not have these distinct layers in place, with each of these layers providing easy "business user" access to allow risk managers to get to the "detail" of the data when regulators, auditors and clients demand it. Regulators are finally waking up to the data issue (see Basel on data aggregation for instance) but more work is needed to pull analytics into the technical architecture/strategy conversation, and not just confine regulatory discussions of pricing analytics to model risk.
Posted by Brian Sentance | 14 February 2013 | 2:50 pm
I got my first tour around the NYSE trading floor on Wednesday night, courtesy of an event by Rutgers University on Risk. Good event, mainly around panel discussion moderated by Nicholar Dunbar (Editor of Bloomberg Risk newsletter), and involving David Belmont (Commonfund CRO), Adam Litke (Chief Risk Strategist for Bloomberg), Hilmar Schaumann (Fortress Investment CRO) and Sanjay Sharma (CRO of Global Arbitrage and Trading at RBC).
Nick first asked the panel how do you define and measure risk? Hilmar responded that risk measurement is based around two main activities: 1) understanding how a book/portfolio is positioned (the static view) and 2) understanding sensitivities to risks that impact P&L (the dynamic view). Hilmar mentioned the use of historical data as a guide to current risks that are difficult to measure, but emphasised the need for a qualitative approach when looking at the risks being taken.
David said that he looks at both risk and uncertainty - with risk being defined as those impacts you can measure/estimate. He said that historical analysis was useful but limited given it is based only on what has happened. He thought that scenario analysis was a stronger tool. (I guess with historical analysis you at least get some idea of the impact of things that could not be predicted even it is based on one "simulation" path i.e. reality, whereas you have more flexibility with scenario management to cover all bases, but I guess limited to those bases you can imagine). David said that path-dependent risks such as those in the credit markets in the last crisis were some of the most difficult to deal with.
Adam said that you need to understand why you are measuring risk and understand what risks you are prepared to take. He said that at Wachovia they knew that a 25% house price fall in California would be a near death experience for the bank prior to the 2008 crisis, and in the event the losses were much greater than 25%. His point was really that you must decide what risks you want to survice and at what level. He said that sound common-sense judgement is needed to decide whether a scenario is really-real or not.
Sanjay said that risk managers need to maintain a lot of humility and not to over-trust risk meaurements. He described a little of the risk approach used at RBC where he said they use over 80 different models and employ them as layers/different views on risk to be brought together. He said they start with VaR as a base analysis, but build on this with scenarios, greeks and then on to other more specific reports and analysis. He emphasised that communication is a vital skill for risk managers to get their views and ideas across.
Nicholas then moved on to ask how risk managers should make or reduce risks? - getting away from risk measurement to risk management. Adam said that risks should be delegated out to those that manage them but this needs to be combined with responsibility for the risks too. Keep people and departments within the bounds of what their remit. Be prepared to talk a different business language to different stakeholders dependent upon their understanding and their motivations. David gave some examples of this in his case, where endowment funds what risk premiums over many years and risks are translated/quantified into practical things for example such as a new college building not going ahead etc.
Hilmar said the hedge funds are supposed to take risks, and that the key was not necessarily to avoid losses (although avoid them if you can) but rather to avoid surprises. Like the other speakers, Hilmar emphasised that communication of risks to key stakeholders was vital. He also added the key point that if you don't like a risk you have identified, then try first to take it off rather than hedging it, since hedging could potentially add basis risk and simple more complication.
Nicholas then Sanjay about how risk managers should deal with bringing difficult news to the business? Sanjay suggested that any bad news should be approach in the form of "actionable transparency" i.e. that not only do you say communicate how bad the risk is to all stakeholders but you come along with actionable approaches to dealing with the risk. In all of his experience and despite the crisis, Sanjay's experience is that traders do not want to loose money and if you come with solutions they will listen. He concluded by saying that qualitative analysis should also be used, citing the hypothetical example that you should take notice of dogs (yes, the animal!) buying mortgages, whether or not the mortgages are AAA rated.
Nicholas asked the panel members in turn what risks are they concerned about currently? David said he believed that many risks were not priced into the market currently. He was concerned about policy impacts of action by the ECB and the Fed, and thought the current and forward levels of volatility are low. In Fixed Income markets he thought that Dodd-Frank may have detrimental effects, particular with the current lack of clarity about what is proprietary trading and what is market-making. He thought that should policies and interests rates change, he thought that risk managers should look carefully at what will happen as funds flow out of fixed income and into equities.
Hilmar talked about the postponement of the US debt ceiling limits and that US Government policy battles continue to be an obvious source of risk. In Europe, many countries had elections this year which would be interesting, and that the problems in the Euro-zone are less than they were, but problems in Cyprus could fan the flames of more problems and anxiety. Hilmar said the Japan's new policy of targetting 2% inflation may have effects on the willingness of domestic investors to buy JGBs.
Sanjay said he was worried. In the "Greenspan Years" prior to 2008 a quasi government guarantee on the banks was effectively put in place and that we continue to live with cheap money. When policy eventually changes and interest rates rise, Sanjay wondered whether the world was ready for the wholesale asset revaluation that would then be required.
Adams concerns where mainly around identifying what will be the cause of the next panic in the market. Whilst he said he is in favour of central clearing for OTC derivatives, he thought that the changing market structure combined with implementing central clearing had not been fully thought through and this was a worry to him.
Nicholas asked what do the panelists think to the regulation being implemented? David said that regulators face the same difficulty that risk managers face, in that nobody notices when you took sensible action to protect against a risk that didn't occur. He thinks that regulation of the markets is justified and necessary.
Sanjay said that in the airline and pharmacutical industries regulatory approval was on the whole very robust but that they were dealing with approving designs (aeroplanes and drugs) that are reproduced once approved. He said that such levels of regulation in financial services were not yet possible due to the constant innovation found in the markets, and he wanted regulation to be more dynamic and responsive to market developments. Sanjay also joined those in the industry that are critical of the shear size of Dodd-Frank.
Nicholas said that Adam was obviously keen on operational issues and wondered what plumbing in the industry would he change? Adam said that he is a big fan of automation but operational risk are real and large. He thought that there were too many rules and regulations being applied, and the regulators were not paying attention to the type of markets they want in the future, nor on the effects of current regulation and how people were moving from one part of the industry to another. Adam said that in relation to Knight Capital he was still a strong advocate of standing by the wall socket, ready to pull the plug on the computer. Adam suggested that regulators should look at regulating/approving software releases (I assume here he means for key tasks such as automated trading or risk reporting, not all software).
Given the large number of students present, Nicholas closed the panel by asking what career advice the panelists had for future risk managers? Adam emphasised flexibility in role, taking us through his career background as an equity derivatives and then fixed income trader before coming into risk management. Adam said it was highly unlikely over your career that you would stay with one role or area of expertise.
Hilmar said that having risk managers independent of trading was vitally important for the industry. He thought there were many areas to work with operational risk being potentially the largest, but still with plenty more to do in market risk, compliance and risk modelling. He added that understanding the interdepencies between risks was key and an area for further development.
When asked by Nicholas, David said that risk managers should have a career path right through to CEO of an institution. He wanted to encourage risk management as a necessary level above risk measurement and control. He was excited about the potential of Big Data technologies to help in risk management. David gave some interesting background on his own career initially as an emergining markets debt trader. He said that it is important to know yourself, and that he regarded himself as a sceptic, needing all the information available before making a decision. As such his performance as a trader was consistent but not as high as some, and this became one of the reasons he moved into risk management.
Sanjay said many of the systems used in finance are 20 years old, in complete contrast with the advancies in mobile and internet technologies. As such he thought this was a great opportunity to be involved in the replacement and upgrading of this older infrastructure. Apparently one analyst had estimated that $65B will be spent on risk management over the next 4-5 years.
Adam thought that there was a need for code of ethics for quants (see old post for some ideas). Sanjay added that the industry needed to move away from being involved primarily in attempting to optimise activity around gaming regulation. When asked by Nicholas about Basel III, Adam thought that improved regulation was necessary but Basel III was not the right way to go about it and was way too complex.
Posted by Brian Sentance | 1 February 2013 | 2:45 pm
Posted by Brian Sentance | 22 January 2013 | 3:14 pm
In relation to the Microsoft/PRMIA event that Brian moderated at last night in New York, I spotted this article recently that tries to map out all the different databases that are now commercially available in some form, from SQL to No SQL and all the various incarnations and flavours in between:
As Brian suggested in his recent post, It's amazing to see how much the landscape has evolved from the domination (mantra?) that there was the relational way, or no way. Obviously times have moved on (er, I guess the Internet happened for one thing...) and people are now far more accepting of the need for different approaches to different types and sizes of business problems. That said, I agree with the article and comments that suggest there do seem to be far too many options available now - there has to be some consolidation coming otherwise it will become increasingly difficult to know where to start. Choice is a wonderful thing, but only in moderation!
Posted by Chris Budgen | 16 January 2013 | 9:30 pm
Went along to a Quafafew event on Tuesday this week, mainly to hear Dan diBartolomeo of Northfield speak. I first heard Dan speak over in London a few years back at an event on quantified news sentiment, whereas on Tuesday he was giving a talk on applying Merton-like contingent claims analysis models to the sovereign risk modelling.
I have always enjoyed (is that the right word?) Contigent Claims Analysis modelling of corporates, and Dan did an interesting talk in extending this methodology to look at sovereigns and the various contingent claims between sovereigns, banks and the "real" economy. I particularly like the concept that one of the main "assets" governments have is the ability to print money. In one of the concluding remarks, Dan said that it was clear to him what the US government was doing in effectively printing money, since local bond holders are effectively insulated (given they have US assets) from the effects of domestic inflation, where foreign bond holders are not. Anyway it was a good presentation by an entertaining and knowledgeable speaker. You can download Dan's presentation by clicking here and it is worth a look for a different view on sovereign risk modelling.
Posted by Brian Sentance | 10 January 2013 | 8:22 pm
Quick thank you to all those who came along to Xenomorph's New York Holiday Party at the Classic Car Club. Below is an extract from talk given by Paul Rowady of the Tabb at the event, followed by my effort and some photographs from the event.
There Is No Such Thing as Alpha Generation
The change in perspective caused by a subtle change in language can galvanize your approach to data, the tools you select, and even the organizational culture. That said, ‘alpha generation’ is a myth; there is only alpha discovery and capture.
By E. Paul Rowady, Jr.
We live in an age of superlatives: unprecedented market complexity and uncertainty caused, in part, by an unprecedented regulatory onslaught and unprecedented economic extremes. As a result, there is an unprecedented focus on risk analysis – and an unprecedented (and anxious) search for new sources of performance from all market demographics.
The big data era is here and will only become the bigger data era. What we need is a new perspective. But fostering such a new perspective may be as subtle as performing a little linguistic jujitsu.
Our business – trading and investment in capital and commodity markets around the globe – has a history of being cavalier or too casual about language; particularly how certain labels, terms or vernacular are used to describe the business and the markets. Some of this language is intentional – the use of certain terminology creates mystique, fosters mythology, manufactures a sense of complexity that only a select group of savants can tame -- particularly when it comes to activities around quantitative methods. And some of it is just plain laziness, stretching the use of labels far beyond their original meaning on the idea that these terms are close enough.
I have become increasingly sensitive to this phenomenon over the years. Call it an insatiable need to simplify complexity, bring order to chaos, to enhance a level of accuracy and precision in how we describe what we do and how we do it. I find that precision of language does impact how complex technical topics are communicated, understood and absorbed. It turns out, language impacts perspective – and perspective impacts strategy and tactics.
So let’s gain a little perspective on alpha generation and alpha creation...(full extract can be found on the TabbFORUM)
Paul in full speech mode at the Classic Car Club
Big thanks to Paul for the above talk. Here's is my follow-up:
Thanks Paul for a great talk, certainly I agree that people, process, technology and data are key to the future success of financial markets. In particular, I think attitudes towards data must change if we are to meet the coming challenges over the next few years. For example, in my view data in financial markets is analogous to water:
- Everyone needs it
- Everyone knows where to get it
- Nobody likes to share it
- Nobody is 100% sure where was really sourced from
- Nobody is quite sure where it goes to
- Nobody knows its true cost
- Nobody knows how much is wasted
- Everyone assumes it is of high quality
- And you only ever know it has gone bad after you have drunk it.
- (I should add, that if you own water you are also very wealthy, so wealthy your neighbor might even consider robbing you)
The problem of siloed data and data integration remains, but this is as much a political as opposed to purely technical problem. People need to share data more, and I wonder (I hope) that as the “social network” generation come through that attitudes will improve, but I guess this will also add different pressures to data aggregators as people are less hung up about sharing information. The focus needs to be on the data that business folks need, and should be less about the type of the data or the technical means by which it is captured, stored and distributed – for sure these are important aspects, but we need involve more people in realizing this cult of data.
And just as Paul has issues with the over-use of “Alpha”, I promise this will be the only time this evening I will mention “Big Data” but today I heard the best description so far of what big data is all about, which is “Big data is like watching the planet develop a nervous system”. Data is fundamental to all of our lives and we are living through some very interesting times in terms of how much data is becoming available and how we make sense of it.
So, a change of tack. When moving to the New York area a few years back, one of my fellow Brits said that you will find the Americans a lot friendlier than the English, but don’t talk to them about politics or religion. So rules are meant to broken, and religion aside I thought I would briefly have to mention the recent election as one of the big differences between the UK and the USA.
Firstly, wow you guys know how to have long elections. I think the French get theirs done in two weeks but even the Brits do it in a month. A few things struck me from the election: I don’t know whether the Democratic Party is generally supportive of legalizing drugs, but I think we can be certain that President Obama spent some time in the states of Colorado and Washington prior to the first debate.
And I hear from the New Yorker that the Republicans are trying a radical new approach to broaden the demographic of the supporter base, apparently to make it inclusive of people who have strong believers in “maths and science”.
Moving on from a light-hearted look at elections but sticking with the government theme, the regulation is obviously very high profile at the moment. To some degree this is understandable as financial markets have been doing a great job of keeping a low profile with:
- JPMorgan $7B London Whale
- Barclays and the Libor rigging
- Standard Chartered and Iranian money laundering
- Knight Capital with the biggest advertisement in history for automated trading
- ING feeling it was missing out on things with Cuba and Iranian money
- HSBC helping Mexican drug lords to move the money around
- Capital One deceiving its customers
- Peregrine Financial Group deceiving the regulators (generating alpha?)
All these occurred in 2012, when it seems that the dust had barely settled over MF Global and UBS. So it is possible to understand the reaction of people and politicians to what has gone on and the need for more stable capital markets, but my biggest concern is that there is simply too much regulation, and complex systems with complex rules is a great breeding ground for the law of unintended consequences. To illustrate how over time we humans, and in particular governments, seem to be regressing in terms of using more words to describe ever more complex behaviours I found the following list online:
- Pythagoras 24 words
- Lords Prayer 66 words
- Archidmedies Priciple 66 words
- 10 commandments 179 words
- Gettysburg Address 286 words
- Declaration of independence 1300 words
- US Govt sale of cabbage 26,991 words
Dodd-Frank is about 2,300 pages, which apparently is going to spawn some 30,000 pages of rules – that is enormous. Listening to a regulator speak last week, he said the regulators had about 10,000 pages done, 10,000 in progress and 10,000 not even started yet. Worse than this, he added that regulators were not trying to shape the financial markets of the future but rather dealing only with the current issues. Regulators should take their lead from quantum physics in my view, as soon as you observe something it is changed. Financial markets are complex, and making them even more complex through overlaying complex rules is not going to result in the stability that we all desire.
Anyway, thanks for coming along this evening and I hope you have a great time. Quick thank you to our clients and partners without whom we would not exist. Thanks to the hard work our staff put in over the year, but in particular thanks to Naj and Xenomorph's NYC team for organizing this evenings event.
Some photographs from the event below. Big thanks to NandoVision for some of the images:
Clients, partners and staff catch up over a drink or three
This waiter had a pleasant interuption in service prior to the fashion show by Hiliary Flowers
Jim Beck talks with PRMIA NYC members: Qi Fu, Sol Steinberg and Don Wesnofske
Cass Almendral, Hillary Flowers and Brian later at the bar
Not sure how this ballet-themed dress works in a convertible?
Russ Glisker and Mark O'Donnell talk cars with Paul
A far more practical outfit for this Porsche
Some of the fashion models rush to discuss the finer points of Alpha Harvesting with Paul...
Thanks again to all involved in putting the party together and for everyone who came along on the night. If I don't get round to another post over the Holiday Season, then best wishes for a fantastic break and a great start to 2013.
Posted by Brian Sentance | 19 December 2012 | 2:42 pm
Just a quick post to highlight Xenomorph's Numerix partnership announcement that went out earlier this week. In summary we have done some great work with Numerix on combining their ability to price and risk manage very complex trades with TimeScape's ability to manage all the data such types of instruments need.
The integration is a great demonstration of the flexibility of TimeScape's data model (see recent post and LinkedIn discussion) and addresses some of the issues discussed and illustrated in an earlier post on data management for risk. Quick thank you to the clients involved in testing and using the integration, to the Numerix team for their assistance on this and to my New York colleagues who led the TimeScape integration work.
Posted by Brian Sentance | 12 December 2012 | 2:36 pm
Good breakfast event from SAP and A-Team last Thursday morning. SAP have been getting (and I guess paying for) a lot of good air-time for their SAP Hana in-memory database technology of late. Domenic Iannaccone of SAP started the briefing with an introduction to big data in finance and how their SAP/Sybase offerings knitted together. He started his presentation with a few quotes, one being "Intellectual property is the oil of the 21st century" by Mark Getty (he of Getty images, but also of the Getty oil family) and "Data is the new oil" by both Clive Humby and Gerd Leonhard (not sure why two people quoted saying the same thing but anyway).
For those of you with some familiarity with the Sybase IQ architecture of a year or two back, then in this architecture SAP Hana seems to have replaced the in-memory ASE database that worked in tandem with Sybase IQ for historical storage (I am yet to confirm this, but hope to find out more in the new year). When challenged on how Hana differs from other in-memory database products, Domenic seemed keen to emphasise its analytical capabilities and not just the database aspects. I guess it was the big data angle of bring the "data closer to the calculations" was his main differentiator on this, but with more time I think a little bit more explanation would have been good.
Pete Harris of the A-Team walked us through some of the key findings of what I think is the best survey I have read so far on the usage of big data in financial markets (free sign-up needed I think, but you can get a copy of the report here). Some key findings from a survey of staff at ten major financial institutions included:
- Searching for meaning in instructured data was a leading use-case thought of when thinking of big data (Twitter trading etc)
- Risk management was seen as a key beneficiary of what the technologies can offer
- Aggregation of data for risk was seen as a key application area concerning structured data.
- Both news feed but also (surprisingly?) text documents were key unstructured data sources being processed using big data.
- In trading news sentiment and time series analysis were key areas for big data.
- Creation of a system wide trade database for surveillance and compliance was seen as a key area for enhancement by big data.
- Data security remains a big concern with technologists over the use of big data.
There were a few audience questions - Pete clarified that there was a more varied application of big data amongst sell-side firms, and that on the buy-side it was being applied more KYC and related areas. One of the audience made that point that he thought a real challenge beyond the insight gained from big data analysis was how to translate it into value from an operational point of view. There seemed to be a fair amount of recognition that regulators and auditors are wanting a full audit trail of what has gone on across the whole firm, so audit was seen as a key area for big data. Another audience member suggested that the lack of a rigid data model in some big data technologies enabled greater flexibility in the scope of questions/analysis that could be undertaken.
Coming back to the key findings of the survey, then one question I asked Pete was whether or not big data is a silver bullet for data integration. My motivation was that the survey and much of the press you read talks about how big data can pull all the systems, data and calculations together for better risk management, but while I can understand how massively scaleable data and calculation capabilities was extremely useful, I wondered how exactly all the data was pulled together from the current range of siloed systems and databases where it currently resides. Pete suggested that this was stil a problematic area where Enterprise Application Integration (EAI) tools were needed. Another audience member added that politics within different departments was not making data integration any easier, regardless of the technologies used.
Overall a good event, with audience interaction unsurprisingly being the most interesting and useful part.
Posted by Brian Sentance | 1 December 2012 | 7:13 pm
Just wanted to start this post with a quick best wishes to all affected by Hurricane Sandy in the New York area. Nature is a awesomely powerful thing and amply demonstrated it is always to be respected as a "risk".
Good event on regulatory progress organised by PRMIA and hosted by Credit Suisse last night. Dan Rodriguez introduced the speakers and Michael Gibson of the Fed began with his assessment of what he thinks regulators have learned from the crisis. Mike said that regulators had not paid enough attention to the following factors:
- Resolvability (managing the failure of a financial institution without triggering systemic risk)
Capital - Mike said that regulators had addressed the quality and quantity of capital head by banks. With respect to Basel III, Mike said that the Fed had received around 2,500 comments that they were currently reviewing. In relation to supervision, he suggested that stress testing by the banks, the requirement for capital planning from banks and the independent stress tests undertaken by the regulators had turned the capital process into much more of a forward-looking exercise than it had been pre-crisis. The ability of regulators to limit dividend payments and request capital changes had added some "teeth" to this forward looking approach. Mike said that the regulators are getting more information which is allowing them to look more horizontally across different financial institutions to compare and contrast business practices, risks and capital adequacy. He thought that disclosure to the public of stress testing results and other findings was also a healthy thing for the industry, prompting wider debate and discussion.
Liquidity - Mike said that liquidity stress testing was an improvement over what had gone before (which was not much). He added that the Basel Committee was working on a quantitative liquidity ratio and that in general regulators were receiving and understanding much more data from the banks around liquidity.
Resolvability - Mike said in addition to resolution plans (aka "living wills") being required by Dodd-Frank in the US, the Fed was working with other regulators internationally on resolvability.
There then followed a Q&A session involving the panelists and the audience:
Basel III Implementation Timeline - Dan asked Mike about the 2,500 comments the Fed had received on Basel III and when the Fed would have dealt with these comments, particularly in the context of where compliance with Basel III for US Banks had been delayed beyond Jan 1 2013. Dan additionally asked whether Mike that implementing Basel III now was a competitive advantage or disadvantage for a bank?
Mike responded that the Fed had extended its review period from 90 days to 135 days which was an unusual occurence. He said that as yet the Fed had no new target data for implementation.
Brian of AIG on Basel III and Regulation - Dan asked Brian Peters of AIG what his thoughts were on Basel III. Brian was an entertaining speaker and responded firstly that AIG was not a bank, it was an insurer and that regulators need to recognise this. He said regulators need to think of the whole financial markets and how they want them to look in the future. Put another way, he implied that looking at capital, liquidity and resolvability in isolation was fine at one level, but these things had much wider implications and without taking that view then there would be problems.
Brian said he thinks of Basel III as a hammer, and that when people use a hammer everything starts to look like a "nail". He said that insurers write 50 year-long liabilities, and as a result he needs long term investments to cover these obligations. He added that the liquidity profile of insurers was different to banks, with life policies having exposures to interest rates more like bank deposits. He said that AIG was mostly dealing with publicly traded securities (I guess now AIG FP is no longer dominant?). Resolvability was a different process for insurers, with regulators forcing troubled insurers to limit dividends and build up cash reserves.
Brian's big concern for the regulators was that in his view they need to look at the whole financial system and what future they want for it, rather than dealing with one set of players and regulations in isolation. Seems Brian shares some similar concerns to Pierre Guilleman on apply banking regulation to the insurance industry, combined with the unintended consequencies of current regulation on the future of the whole of financial markets (maybe the talk on diversity of approach is a good to read on this, or maybe more recently "Regulation Increases Risk" for a more quantitative approach).
Steve of Credit Suisse on Basel III - Dan asked Steven Haratunian whether implementing Basel III was a competitive advantage or disadvantage for Credit Suisse. Steve said that regardless of competitive advantage, as a Swiss bank Credit Suisse had no choice in complying with Basel III by Jan 1 2013, that Credit Suisse had started its preparations since 2011 and had been Basel 2.5 compliant since Jan 1 2012. He said that Basel III compliance had effectively doubled their capital requirements, and had prompted a strategic review of all business activities within the investment banking arm.
This review had caused a reassessment of the company's involvement in areas such as fixed income and risk weighted assets had been reduced by over $100Billion. Steven explained how they had looked at each business activity and assessed whether they could achieve a 15% return on equity over a business cycle, plus be able to withstand CCAR stress testing during this time. He said that Credit Suisse had felt lonely in the US markets in that they were many occaisions where deals were lost due directly to consideration of Basel III capital requirements. Credit Suisse felt less lonely now given how regulation is affecting other banks, and that for certain markets (notably mortgages and credit) the effects of Basel III were very harsh.
Volcker Rule and Dodd-Frank - Dan asked Mike where did the Volcker Rule fit within Dodd-Frank, and does it make us safer? Mike didn't have a great deal to say on this, other than he thought it was all part and parcel of Congress's attempts to make the financial markets safer, that its implementation was being managed/discussed across an inter-agency group including the Fed, SEC and CFTC. Brian said that Dodd-Frank did not have a great deal of impact for insurers, the only real effects being some on swap providers to insurers.
Steve said that many of the many aspects or "spirit" of Volcker and Dodd-Frank had been internalised by the banks and were progressing despite Dodd-Frank not being finalised. He said that in particular the lack of certainty around extraterritoriality and margining in derivatives was not helpful. Mike added that in terms of progressing through Dodd-Frank, his estimated was that the Fed had one third of it finished, one third of the rules proposed, and one third not started or in very early stages. So still some work to be done.
Living Wills - Brian at this point referred to a recent speech by William C. Dudley of the Fed with title "Solving the Too Big to Fail Problem" (haven't looked at this yet, but will). Mike said that the Fed was stilling learning in relation to "Living Wills" and eventually it will get down to a level of being very company specific. Brian asked whether this meant that "Living Wills" would be very specific to each company and not a general rule to be applied to all. Mike said it was too early to tell.
Extraterritoriality - On extraterritoriality Steve said that Credit Suisse having to look at its subsidiaries globally more as standalone companies when dealing with regulators and capital requirements, which will great increase capital requires if the portfolio effect of being a global company is not considered by regulators. Dan mentioned a forthcoming speechto be made by Dan Tarullo of the Fed, and mentioned how the Fed was looking at treating foreign subsidiaries operating in the US as bank holding companies not global subsidiaries, hence again causing problems by ignoring portfolio effect. Mike said that the regulators were working on this issue, and that unsurprisingly he couldn't comment on the speech Dan Tarullo had yet to make.
The Future Shape of the Markets - Brian brought up an interesting question for Mike in asking how the regulators wanted to see financial markets develop and operate in the future? Brian thought that current regulation was being implemented as almost the "last war" against financial markets without a forward looking view. He said that historically he could see Basel 1 being prompted by addressing some of the issues caused by Japanese banks, he saw Basel II addressing credit risk but what will the effects of Basel III ultimately be?
This prompted an interesting response from Mike, in that he said that the Fed is not shaping markets and is dealing only with current rules and risks. He added that private enterprise would shape future markets. (difficult to see how that argument stacks up, regulation implemented now is surely not independent of private sector reaction/exploitation of it) Steve added that Basel III had already had effects, with Credit Suisse already reducing its activity in mortgage and fixed income markets. Steve said that non-banking organisations were now involved in these markets and that regulators have to be aware of these changes or face further problems.
Did Regulators Fail to Enforce Existing US Regulation - one audience participant was strongly of the opinion that Basel III is not needed, that there was enough regulation in place to limit the crisis and that the main failing of the regultors was that they did not implement what was already there to be used. Mike said he thought that the regulators did have lessons to learn and that some of the regulation then in place needed reviewing.
Keep it Simple - another audience member asked about the benefits of simple regulation of simpler markets and mentioned an article by Andrew Haldane of the Bank of England on "The Dog and the Frisbee". Mike didn't have much to add on this other than saying it was a work in progress.
Brian thought that the central failure behind the crisis was the mis-rating of credit instruments, with AAA products attracting a 4bp capital charge instead of a more realistic 3%.
Regulations Effects on Market Pricing - Steve was the first to respond on this, pointing to areas such as cmbs and credit markets as being best performing areas that also have the lower capital risk weights. Dan said he felt that equity markets had not fully adjusted yet, and ironically that financial equities had the highest risk weights. Combined with anticipated rises in tax, high risk weightings were taking capital out of the risk bearing/wealth generating parts of the economy and into low weighted instruments like US treasuries. Dan wondered whether regulation was one of the key dampening factors behind why the current record stimulus was not accelerating the economy in the US more quickly.
Derivatives Clearer and Clearing - this audience question was asking how the regulators were dealing with the desire to encourage clearing of derivative trades whilst at the same time not incentivising the banks to set themselves up as clearers. Mike said that there was an international effort to look at this.
What Happens When the Stimulus Goes - an audience member asked what the panel thought would happen once the stimulus was removed from the markets. The panelists thought this was more an economics questions. However Dan said that the regulators were more sensitive to the markets and market participants when considering new stimulus measures, and cited problems in the fall of 2011 caused by Fed actions in the market crushing mortgage spreads. Brian said insurers need yield so the stimulus was obviously having an impact. Dan mentioned that given the low risk weighting of US Treasuries then everyone was holding them and so the impact of a jump in rates would hurt many if done without preparation.
Wine Shortage and Summary - Just had to mention that there was no wine made available at the networking session afterwards. A sign of austere times or simply that it was too early in the week? Anyway it was a great discussion and raised some good points. In summary, all I hear still supports the premise that the "Law of Unintended Consequences" is ever-present, ever-powerful and looming over the next few years. Hearing regulators say that they are dealing with current risks only and are not shaping the future of financial markets smacks of either delusion or obfuscation to me.
Posted by Brian Sentance | 28 November 2012 | 6:22 pm
Launch event for Interactive Data's new reference data service Apex on Wednesday night, hosted at Nasdaq Time Square and introduced by Mark Hepsworth. Apex looks like a good offering, combining multi-asset data access, batch file and on-demand API requests from the same data store, plus hosted data management services, and a flexible licensing/distribution/re-distribution model.
Some good speakers at the event. Larry Tabb ran through his opinions on the current market, starting with regulation. He painted a mixed picture of the market, starting with the continuing exit by investors from the equity mutual funds market, offset to some degree by rapid growth in ETF assets (54% growth over past 3 years to $1,200billion). Obviously events such as the Flash Crash, Libor, the London Whale and Knight Capital have not increased investors confidence in markets either.
On regulation he first cited the sheer amount of regulation being attempted at the moment going through systemic risk/too big to fail, Dodd-Frank, Volcker, derivatives regulation, Basel III etc. Of particular note he mentioned some concerns over whether there is simply enough collateral around in the market given increased capital requirements and derivative regulation (a thought currently shared by the FT apparently in this article).
Given the focus of the event, Larry unsurprisingly mentioned the foundational role of data in meeting the new regulatory requirements, which for the next few years he believes will be focussed on audit and the ability to explain and justify past decisions to regulators. Also given the focus of the event, Larry did not mention his recent article on the Tabb Forum on federated data management strategies which I would have been interested to hear Interactive's comments on, particularly given their new hosted data management offerings. (You can find some of our past thoughts here on the option of using federated data.)
Mike Atkin of the EDM Council was next up and described a framework for what he thought was going on in the market. In summary, he split the drivers for change into business and regulatory, and categorised the changes into:
- Systemic Risk
- Capital and Liquidity
- Clearing and Settlement
- Control and Enforcement
He then that the fundamental challenge with data was to go through the chain of identifying things, descibing them, classifying/aggregating them and then finally establishing linkages. He then ended this part of his presentation with the three aspects he thought necessary to sort this out from industry data standards, to methods of best practice and on to having infrastructure in place to enable these changes.
Mike then went on to recount a conversation he had had with a hedge fund manager, who had defined the interesting concept of a "Data Risk Equation":
N x CC x S / (Q x V)
N: is the number of variables
CC: is a measure of calculation complexity
S: is the number of data sources needed
Q: is a measure of quality
V: is a measure of verifiability
I think the angle was the Hedge Fund guy was simply using a form of the above to categorise and compary the complexity of some of the data issues his firm was dealing with.
Aram Flores of Deutsche Bank then talked briefly. Of note was his point that the new regulation was forcing DB to use more external rather than internal data, since regulation now restricted the use of internal data within regulatory reporting. Sounds like good news for Interactive and some of its competitors. Eric Reichenberg of SS&C GlobeOp then gave a quick talk on the importance of accurate data to his derivative valuation services. The talks ended with a well-prepped conversation between Marty Williams and one of their new Apex clients, who jokingly refered to one of the other well-known data vendors as the Evil Empire which raised a few smiles - fortunately the speaker didn't start to choke at this point so obviously Darth Vader wasn't spying on the proceedings...
So overall a good event, new product offering looks interesting, speakers were entertaining and the drinks/food/location were great.
Posted by Brian Sentance | 26 October 2012 | 2:18 am