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Comparing Internet Risk Management Services

You can get access to powerful risk management analytics over the Internet for little or no cost. But you'll have to live with some limitations.

By Jennifer Fitzgibbon and Gideon Pell

The derivatives world is filled with end-users who want access to high-end derivatives pricing and risk management analytics but can't afford the cost. They may be thrilled to learn that they can access some of what they want via three subscription-based risk management services available over the Internet or private intranets. All three services allow users to enter their portfolios and look at current mark-to-market values, value-at-risk numbers at a desired level of confidence and period, and portfolio returns viewed over time.

Each system plays to its own strengths and target audience. Reuters' Var-Net offers asset managers access to its powerful Sailfish calculation engine—the same comprehensive risk reporting and historical market data that major banks use. Integral's RiskNet offers corporate treasurers derivatives pricing and exposure analysis around the clock at a reasonable cost. It also helps them comply with the SEC's corporate disclosure requirements. Infinity's riskview.com, by contrast, focuses on giving stock investors quantitatively derived risk/return analyses and access to global market indices for performance evaluation.

Although the three systems may be ideal for end-users who need limited analytical services, the three systems must make significant advances before they can become viable alternatives to larger system purchases.

Easier log-in access, faster on-line performance, broader product coverage, real-time market updates and global position uploads would all be welcome improvements.

VaR-Net

Reuters' VaR-Net
In brief: Sophisticated portfolio analytics on a wide variety of instruments
Cost: Monthly fee, based on usage

Var Net
Contact:
Jay Burstell
Reuters America Inc.
40 East 52nd St.
New York, NY 10022
212-593-5575
e-mail: jay.burstell@reuters.com
Internet: www.var-net.com

Reuters America's VaR-Net is the most sophisticated and perhaps easiest to use Internet access system. It requires no user maintenance and manipulation. For a modest monthly fee users access risk reports produced by the Sailfish RiskManager system, Reuters' comprehensive middle-office risk management product. The system can handle a broad range of foreign exchange, fixed-income, equity and commodity derivatives as well as their underlying securities. The newest release of Sailfish RiskManager (3.4) features multiple methodologies for calculating value-at-risk, measuring performance and allocating capital.

Before using VaR-Net, clients must first detail their portfolio specifications and valuation parameters to Reuters professionals, who then set up the portfolio on Sailfish's RiskManager. Subscribers can specify a combination of profit centers, markets, instrument types, product types, currencies and time periods for each portfolio, with which to view their risks. Subscribers can also request customized risk parameters such as standard deviation, holding period and other risk types, such as interest rate, currency and price volatility. Once the portfolio is established, subscribers e-mail portfolio updates to Reuters via delimited ASCII files, which are then uploaded into the client's Sailfish RiskManager database by Reuters. Subscribers can then log on and access risk reports for various time periods (daily, weekly, quarterly and so on). All transfer of information occurs in the secure, high-performance environment of the Reuters private network (intranet).

The advantage to this methodology is that subscribers do not have to invest in hardware, software or a support infrastructure. "Reuters essentially acts as a type of service bureau,” explains Jay Burstell, director of Reuters' Risk Management Unit. "This product is ideal for money managers who do not want to invest in the internal resources necessary for a control group.” Reuters allows users to run portfolios against historical time series on fixed-income, derivatives and emerging markets, some of which go back 10 years or more. Users must provide their own data sets with implied option volatilities, however, if they wish to simulate the distribution of values for option portfolios.

VaR-Net's Three Main Views of Risk

VaR-Net's risk histogram presents a portfolio's theoretical profit and loss over the sample period. The normal distribution is superimposed over this, enabling easy visual comparison and identification of any clustering of returns. The information is color-coded, with the portfolio information in green and the normal curve in red. The number of buckets in the histogram may be set according to the resolution of the display and can be specified before the reports' preparation.

The risk timeline allows users to view what happened when and assess whether or not a particular time frame adequately captures the extreme periods in the given sample. It is also easy to identify the values-at-risk in terms of standard deviations. Each red horizontal line represents one standard deviation and the green timeline is the actual returns for the individual days being evaluated. The actual value-at-risk is shown on the Y-axis and the day of the occurrence on the X-axis.

The Risk Profile presents the same data in a profile fashion with the confidence intervals on the X-axis. The confidence intervals, however, deviate slightly with standard notation because the range from the far left to the far right of the chart represents 95 percent of the losses to 95 percent of the gains. This format enables viewers to see how the implied and normal distributions relate to each other over all probabilities. The worst-case and best-case value-at-risk by amount are displayed with the amounts and date of each occurrence. In many cases, this is a clearer representation of value-at-risk than the histogram, which displays occurrences rather than probabilities. The risk profile is especially helpful for viewers who are interested in determining the worst-case scenario over the specified period.

VaR-Net offers a number of comprehensive reports that allow users to calculate, detail and analyze a particular portfolio's value-at-risk. A risk detail report compares the portfolio's actual distribution with the normal distribution and displays portfolio characteristics such as mean, standard deviation, skew and kurtosis. It also specifies useful information such as the number of up and down days (compared with the normal distribution of returns) and the aggregate-up and aggregate-down amounts. It can be run for each risk type or all risk types combined. The report displays information in three different options—histogram, time line and profile. (See box.)

Other reports provide equally valuable views of risk. The risk grid report enables subscribers to view which currency or product produces the highest potential profit and loss volatility. It displays risk allocations within the specified portfolio in tabular and graphical form using four quadrants. The data in the first quadrant indicate the total value-at-risk for each instrument type, product, market, period, currency and profit center within the portfolio. Here the aggregate value of all the components is also shown, as well as the overall value-at-risk. The second quadrant graphically displays the value-at-risk for each product type or group. The third and fourth quadrants display information regarding the types of risk for low and high holding periods and a breakdown of value-at-risk by a particular time period or set of currencies, which can be specified by the subscriber.

The risk rank report shows the 10 events with the largest gains and losses and portfolio percentile ranked returns. This report is especially helpful in assessing the symmetry of return (that is, whether the absolute value of the worst loss is higher than that of the worst gain). The report breaks the risk down into the different risk types in presenting the overall extreme case numbers. It also provides the percentile ranked returns for the portfolio.

Overall, VaR-Net offers users a visually appealing and easily accessible way to get a value-at-risk snapshot of a given portfolio. The only drawback is that the reports displayed by VaR-Net are for viewing only, and lack the interactive point-and-click navigation and customization capabilities available on the larger Sailfish system. As a result, it's crucial that subscribers specify exactly what kind of information is needed from the outset.

riskview.com

Infinity's riskview.com
In Brief: Pricing and risk
management analytics for equity portfolios
Cost: Free

riskview.com
Contact:
Partick Suel
Infinity Financial Technology
640 Clyde Court
Mountain View, CA 94043
415-940-6100
e-mail: patrick_suel@infinity.com
Internet: www.riskview.com

The web site riskview.com is a free site sponsored by Infinity Financial Technology Inc., in cooperation with Dow Jones Global Indexes and IBM. To access the system, users simply download an applet with their Internet browser. (The site works well with Netscape 4.0.)

Investors set up a portfolio by selecting stocks and indices from the DJGI menu. The stocks can be sorted by region or country, and then by sector or industry. Price data from DJGI span the past five years and have been adjusted for corporate actions, stock splits, rights issues and so on. Users, Infinity boasts, can choose from more than 3,000 stocks and 4,000 indices from eight regions, 29 countries and 121 industry groups.

Once a portfolio has been created and stored, investors can track investment results each day, and compare performance with a user-defined index. They are then able to analyze the performance of an individual stock or the whole portfolio in terms of price or return against a specified benchmark. This allows users to examine how well a stock has performed, the gain or loss if the stock had been bought at a given time and the stock's performance on a risk-adjusted basis. Performance can be displayed for each stock as well as on the portfolio level. Users can also choose the base currency for displaying values and the tax rate to show the returns on an after-tax basis.

The site's risk/return analysis allows investors to assess how risky their investments might be in comparison with their return by showing risk numbers relative to a benchmark (see box). Risk measures for each stock reflect estimated volatilities calculated using historical data and are displayed in candle graphs showing the average, high, low and range of the annualized forecasted volatility. Historical and forecasted volatilities are available, differentiated only by the weighting given to past price returns. The scatter plot of daily returns graphs the daily return of the portfolio against the daily return of the benchmark. The dispersion highlights the degree to which the portfolio's returns were correlated with the benchmark's returns.

Investors who want to go further can examine the tradeoff between risk and return for each security, the overall portfolio and the benchmark (see box). Of greatest interest will be the securities lying to the left of the 45ή line on the risk-return plot, since these attracted higher returns for less risk. An interesting feature is the ability to click on one of the colored dots, which causes the name of that stock to appear in the center of the screen. Another way of looking at relative performance is by fitting a regression line to the scatter plot of daily returns of each security against the benchmark over the period under review. The slope of the line, beta, indicates the extent to which the return on the security changed, on average, with the benchmark. Alpha represents the return not explained by general market shifts (that which is specific to the security).

Investors who wish to track the performance of their portfolios over time can view a graph showing the value of a unit invested from the inception of the period for both the portfolio and the benchmark. Another graph depicts the movement of prices or returns for each stock, the portfolio and the benchmark to allow for direct comparison among the different stocks.

RAROC Gets Affordable

The granddaddy of all risk management methodologies was RAROC (risk-adjusted return on capital), developed over the course of more than 20 years at Bankers Trust. The company began marketing a high-end risk management service to high-end institutional investors in 1995, often with a six-figure price tag. Now, the company has done an about face, offering risk reporting for as little as $25,000 a year.

Institutional investors who subscribe to the service receive regular comprehensive reporting on the financial risks across their entire portfolios. The service is part of the global institutional services area at Bankers Trust, which provides custody and trust services for the bank's customers. Instead of providing software for customers to integrate into their data systems and operate, the RAROC 2020 service bureau conducts the analysis for customers, receiving basic data from the custodian of the assets, and delivers the finished, highly customized risk report to the client.

RAROC 2020 models risk at the security and portfolio level. It explicitly recognizes that complex securities incorporate a variety of risks and that these risks cut across traditional asset class boundaries. It incorporates assets with non-normally distributed returns, such as options and other complex derivatives (convertibles, mortgages, CMOs and so on). To facilitate this, it uses Monte Carlo simulation, and draws on the correlations and volatilities of more than 500 risk factors to model the portfolio holdings.

Typical clients include pension plans, financial institutions and investment management firms with more than $300 billion in assets. The company notes that pricing is predominantly a function of the number of portfolios covered under the analysis and the frequency of reports.

For more information, contact:

Michele McCarthy
Bankers Trust Co.
130 Liberty St.
Mail Stop 2217
New York, NY 10006
Tel: 206-325-2020
Fax: 206-328-9055

The most useful tool is likely to be riskview.com's value-at-risk calculator. Based on a user-defined confidence interval and forecast period, the VAR screen shows the value and VAR of each of the stocks in the portfolio. The VAR lets investors know, with a certain probability, how much money their portfolios may lose in the following day (or days) based on the forecast volatilities and correlation. Because of the correlation of returns, the total VAR of the portfolio is usually less than the sum of the individual VARs. The table also shows the contribution of an individual security to the overall portfolio VAR, both on an absolute scale and relative to the specified benchmark. As a security's returns are more correlated with the benchmark, the relative VAR will be lower. Sensitivity graphs illustrate how the estimated losses change with the confidence interval.

Not surprisingly, as a free site, riskview.com has a few drawbacks. Performance can be somewhat slow, the product coverage is limited to the DJGI universe (excluding small-cap stocks) and there is little customer support. Users are advised to obtain shareware utilities to capture and print screen slots because the software itself does not support printing the reports. Currently, portfolios are limited to 20 stock positions, although up to another 30 stocks can be analyzed individually.

The site is, in reality, merely a teaser to allow the sponsors to explore the potential interest in the marketplace. The interest seems to be there. According to sources at Infinity, there are currently more than 100,000 registered users, and this number is growing rapidly. If this trial is successful, the web site sponsors hope to license the technology to on-line brokers, retail brokers and fund managers, who could offer clients instant access to risk and return analysis on their investment accounts. Patrick Suel, business development manager at Infinity, points out that the company is currently in discussion with one such financial intermediary that wants to broaden the product coverage to fixed income, futures and options, and to facilitate portfolio uploads from spreadsheets.

RiskNet

Integral's RiskNet
In Brief: Low-cost fixed-income and derivatives pricing analytics for corporate treasurers
Cost: About $20,000 per year, plus usage charges

RiskNet
Contact:
Tim Westhoff
Integral Development Corp.
140 Broadway
46th Floor
New York, NY 10005
212-269-3900
e-mail: tim.westhoff@integral.com
Internet: www.integral.com

RiskNet is a subscription-based risk management system designed and maintained by Integral Development Corp. The system runs off of Integral's Universal Finance Server (UFS), which supplies pricing, portfolio and analytical information. RiskNet provides live updates of financial data, objective accurate pricing, deal modeling and hedging analysis, portfolio mark to market, and VAR analysis. The system can be accessed from any PC equipped with an Internet browser.

RiskNet is being promoted primarily to corporate treasurers looking to price and assess the risk from derivatives using similar analytical techniques to those used by the banks and brokers.

RiskNet can accommodate a range of instruments including fixed-income bonds, currency forwards and options, currency and interest rate swaps, and interest rate options. (Futures and exotic options appear on the instrument menu but are not yet available.) Subscribers enter deals on screen-based trade tickets from the menu of instruments currently supported by the system. Users can either input trades manually or upload groups of trades using a spreadsheet template, although the upload feature wasn't working when we logged onto the site.

Web-based Risk Systems
VarNet RiskNet RiskView
Product coverage
Full range of cash and derivative instruments •
Partial set of cash and derivative instruments •
Equities only •
Reporting capabilities
Interactive reports and drill-down • •
Daily mark-to-market and P&L, with historical summary • • •
Probability distribution of daily returns • •
Compares portfolio distribution with the normal distribution •
Returns and risk relative to benchmarks • •
Shows components of risk for individual trades/portfolios • • •
VAR and stress testing
VAR displayed by security and portfolio • • •
User-defined confidence interval and holding period • • •
What-if yield curve shifts and scenario analysis specified by user • •
Supports Monte Carlo simulations
Market data
Live updates of market data • •
Yield curve generation from market inputs • •
Volatilities and correlations
based on minimum of one year history
• • •
Supports non-G7 currencies • •
Other features
Software freely available •
No restriction on size of portfolio • •
Upload positions from spreadsheets • •
Supports printing of analysis and results • •
Helpful on-line documentation •
Extensive graphical and visual effects • •

Users complete input fields to describe the specific attributes of each transaction, including day count convention, payment dates and amortization type to complete the trade ticket. The pertinent trade pricing then appears below, including current valuation, the effect of a 1-basis-point move (NP01), current yield and modified duration. Deals entered can then be saved into a portfolio for subsequent retrieval and analysis.

Hitting the events button displays the schedule of principal and interest cash flows until the maturity date of the transaction. Discount factors used to compute the NPV of the instrument are shown against each cash flow. These factors are derived from yield curves dynamically constructed by the risk system for the seven major currencies. The market inputs to each yield curve—deposits, futures and par swaps—are fully described and are updated during the day. Implied option volatilities are not provided; users must input their own estimates if they wish to price a currency or interest rate.

Various what-if scenarios can also be applied to the portfolio. The yield curve can be subjected to three different stresses: a parallel shift (up or down), a tilt where rates are shifted in different directions to represent steepening or flattening scenarios, and a hump where the curve is bumped up or down at one point only. Portfolio sensitivities to these yield curve shifts are reported with a graph of the corresponding changes in the yield curve. The portfolio can also be stressed to changes in the spot exchange rates. It is not possible, however, to subject the portfolio to multiple scenarios simultaneously, such as showing the effect of shifting the Deutsche mark yield curve up by 10 basis points and a 5 percent decline in the U.S. dollar/Deutsche mark spot rate.

In order to capture the effect of correlation of returns between different risk factors, a parametric VAR calculator is available, using a direct link into JP Morgan's RiskMetrics data set. Users can select the desired holding period and select confidence intervals of 90 percent, 95 percent or 99 percent. The VAR for each trade within the portfolio is clearly presented, along with the amount that has been diversified away as a result of correlations within the portfolio. A daily summary report displays the change in mark-to-market from the previous day and plots VAR against the corresponding change in the mark-to-market for each day in the period. This allows users to back-test the accuracy of the risk numbers against the actual results of the portfolio.

In its promotional material, the company says that RiskNet is available 24 hours a day, 365 days a week and is a plug-and-pay solution to the management of financial derivatives. The reviewers found, however, that certain reports and features were not fully functional, as noted earlier. The site itself had the feel of a beta version and needs some upgrading before it can realistically be implemented as a production system for daily VAR and profit-and-loss reporting. Once the improvements are made, however, this product could very well be the solution to many corporate treasurers' risk management quandaries.

(Jennifer Fitzgibbon is head of risk control and analysis at Bayerische Vereinsbank. Gideon Pell is a first vice president in global risk assessment at Republic National Bank of New York. This article was extracted from a paper written for an MBA course in risk management systems taught by professor Allan Grody at the Stern School of Business, New York University.)

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