In the never-ending search for alpha, particularly with recent years’ rise of passive management, active managers need the flexibility to easily move into new regions and/or asset classes. Legacy systems are inherently hamstrung here as they were designed long before many new asset classes were even considered investments. The so called “best-of-breed” strategy is also problematic because introducing a new platform just to support a new investment opportunity requires another interface and reconciliation point.
In the recent survey, 66% of North American front office leaders said that reducing the operational costs, which impact the profitability of their fixed income desk, was the number one priority. An additional 63% said that implementing new fixed income technology was a key priority for 2018. These required technological enhancements, coupled with the constant pressure to reduce costs, indicate that the current operational environment of legacy and best-of-breed systems cannot support the long-term strategy of fixed income desks, and are also an expensive burden on day-to-day front office activities and P&L.
Challenges facing the front office and hence fixed income desks
At the same time, the front office continues to be concerned about compliance and risk management. Disparate systems present significant challenges for both. If you run equities on one platform, fixed income on another, FX outside of both and then try to tie them all into a different accounting platform, it is nearly impossible to get a clear picture of your firm-level risk parameters and adherence to compliance rules. A surprising number of well-known investment managers have abandoned any real pre-trade compliance because it is effectively pointless given their inability to see across multiple systems and asset classes.
According to the WBR Insights report, fixed income desks face a number of critical challenges:
- 81% are hampered in understanding firm wide limits, counterparty exposure and other important risk indicators
- 70% find securing timely and accurate start of day/intraday positions and cash projections challenging
- 59% struggle to measure investment performance relative to blended benchmarks/indices
- 56% spend up to an hour reconciling positions and cash at the start of their day, just to reach a ‘satisfactory confidence level’
The negative impact of short-term tactical decisions of the past
Today, many fixed income desks are impeded by a history of adding additional systems and interfaces whenever a new challenge has arisen. As a result, they are now not only faced with increasing maintenance costs, but also heightened investment and operational risk, caused by timing of data gaps between the multiple systems put in place, to support the investment lifecycle. To date, many firms have attempted to overcome this obstacle by deploying more resources to fill in these critical gaps. With tighter margins leading to leaner teams, this is no longer sustainable and more importantly, is eating into time spent on vital alpha generation.
In the recent survey, 66% of North American front office leaders said that reducing the operational costs, which impact the profitability of their fixed income desk, was the number one priority. An additional 63% said that implementing new fixed income technology was a key priority for 2018.Terry Flynn, Front Office Specialist, SimCorp North America
Breaking free of the limitations of “best of breed”
The report’s findings make it clear that fixed income operations need to undergo significant change. For years now, investors have ploughed their assets into cheap multi-asset ETFs. Fixed income professionals have a real opportunity to fight off this passive trend, but to succeed they must first confront the fragmented operations that burden their daily lives. Delayed and incomplete data, limited firm-wide exposure views, restrictive asset class coverage, and Excel-driven manual reconciliation, have tied the hands of many fixed income desks.
To free themselves of this burden, firms need to eliminate the bottlenecks by consolidating their investment operations. This will create the operational efficiency required to deliver competitive returns and attract and retain investors.
From best-of-breed patchwork to a consolidated platform
It is not surprising that reducing operational cost and improving profitability of the fixed income desk is the number one priority for 2018. Given the current state of fixed income systems, this challenge cannot be met using the old way of doing things – i.e. adding new platforms into the already complex mix of systems. It is clear that these desks have an opportunity to make real changes, including system consolidation, to resolve these ongoing structural issues.
We believe that best-of-breed has run its course. Additional pressures including new regulations, decreased liquidity, increased fragmentation, and electronification of fixed income trading are combining to make the fixed income markets tremendously complex and of course, a great source of alpha for quality active managers who have the right technology in place.
The results of the WBR Insights report show a lack of connection between the heads of fixed income desks and the operations function and a gap in understanding as to how operations can contribute to the fixed income team’s goals. It is hard to see how fixed income managers will be able to make progress on their 2018 priorities including identifying new region and/or asset class opportunities (62%), improving firm wide compliance (51%), improving risk management (58%), and implementing new fixed income technology (63%) without better collaboration with the operations team.
Consolidating the front office with the rest of the value chain
Investment management firms who want to step up their fixed income game must ask themselves: Have you kept your systems and operations current and unified in order to properly measure your level of success with these instruments vs. alternative options? Are you confident in your team’s ability to profitably handle the fixed income instruments you want to focus on?
This decisive time in the markets, where conditions are expected to “go back to normal,” in terms of volatility, inflation, and others, presents an opportunity for investment management firms and heads of front office to question the status quo, and ask if multiple systems still make sense, or if consolidation, and a closer relationship with operations would be a better option.
The report comes at a pivotal time and unveils the impact costly and ineffective fragmented operations have on the chance for success of fixed income desks.
1. Jamie McGeever, “Column, 2017, the year of the active fund manager?” Reuters, December 27, 2017.
2. ‘Fixed Income 2018: Goals and Challenges for the Front Office’, WBR Insights, 2018.