Painpoints and Possibilities – The 2019 Fixed Income Technology Landscape: Part 1

The 2019 Fixed Income Technology Landscape

Part 1: Painpoints and Possibilities

In today’s operating environment, asset managers have begun to rethink how they utilize technology due to a confluence of factors. The complexity of fixed income market structures, compressed margins and increased regulation have all been catalysts for technology adoption and operational change. Any one of these factors can be detrimental for the investment operations of an asset manager… combined, they strain capacity and cut into the profit margins of the business.

The fixed income markets have not kept up with the rapid rate of technological advancement that can be observed across other asset classes. However, that does not mean bond investors aren’t looking to innovate.

Fixed income managers face a unique set of technology challenges. Pain points range from data management and portfolio reporting, to compliance, middle and back office operations, trade reconciliations and many more. A good number of these challenges can be mitigated with the appropriate technology applications and systems.

Of the more than 500 investment executives surveyed in State Street’s 2018 “New Routes to Growth” survey, respondents identified emerging technologies as the leading opportunity to grow revenue. Fixed income asset managers have the resources to transform technology from a headwind to a competitive advantage when it is utilized effectively to improve processes, increase transparency and address the operational burden of regulatory changes.

While fixed income asset managers have a diverse set of investment processes and objectives, the common denominator among all managers lies in their need to leverage technology due to the ever-changing operating requirements of the markets. Bond managers have come to rely upon third party solutions as a cost-effective means of maintaining best-in-class systems, in lieu of building these tools in house. Managers can choose between a front-to-back system which consolidates applications across a single platform or implement a combination of best-of-breed tools where a firm identifies and integrates the applications believed to be best suited for their investment processes.

Before selecting the most effective technology systems, it is crucial for PMs and investment operations personnel to review their business requirements and determine the most effective applications based on their organization’s objectives. This 3-part series will explain how asset managers can review their current investment systems, establish a long-term technology strategy and successfully implement the appropriate solutions.

Understanding the Options: Investment Processes vs. Operational Procedures

The range of tools available in today’s market reflects the increased diversity of operations among fixed income managers. To fully understand the role that technology plays in the asset management lifecycle, it is helpful to categorize the technology functions under two universes: investment decision-making & execution and operational functions, although both are intertwined throughout the portfolio lifecycle. Nonetheless, investment processes and operational procedures can vary significantly from one asset manager to another.

An Asset Manager’s Technology System

Investment Processes vs. Operational Procedures | CBXmarket | Fixed Income Technology

*For illustrative purposes only. Not comprehensive

While structure and setup of investment decision-making and execution functions may differ between firms, asset managers all conduct elements of portfolio management, risk management and trading. Portfolio managers make investment decisions in order to meet performance objectives while operating within a set of portfolio objectives and constraints. Investors rely heavily on data, risk models and analytics to inform their investment decision processes. While many asset managers develop risk models and analytical measures internally, it is commonplace for PMs to turn to vendors to provide tools and technology solutions for enhanced reporting and transparency to inform their portfolio management processes.

Beyond portfolio management, many fixed income units have a risk management arm that is separate from portfolio managers. Risk managers work closely with PMs to ensure that portfolios are being managed in accordance to set guidelines and various risk parameters. Risk managers also need accurate pricing and security data along with complex models to fulfill their responsibilities.

The third arm of the investment decision-making domain is trading. Trading involves the generation of orders, primarily processed via an order management system (“OMS”), and the execution of those orders with market participants. This is an area that is ripe for technological change as 80% of US Corporate fixed income trades by notional value were executed telephonically as of 2017.

While investment decision-making and execution are the primary front-office functions of the asset management firm, middle- and back-office roles are equally as important. After a trader says “Done”, there are a myriad of processes to be completed across the compliance, accounting and investor relations teams. Trades need to be settled, cash must be properly tracked and moved and systems require regular reconciliation to ensure reporting is in line with the firm’s IBOR (“investment book of records”) where all transactions are recorded and reconciled.

Operational functions of the asset manager can be tedious, manual processes if they are not technology-enabled. Given that middle- and back-office functions are so resource intensive, some asset managers have decided to fully or partially outsource those laborious functions to a number of different vendors.

Data is fundamental to facilitating every action that asset managers performfrom portfolio management to operational functions such as settling trades, recordkeeping and compliance. Investors require a large array of data on a daily or intra-daily basis, requiring them to purchase feeds from multiple vendors. These systems allow PM’s to codify and process millions of data points for evaluating investment opportunities, modeling trades and benchmarking historical performance.

Historically, asset managers relied on internally-developed technology solutions in concert with manually maintained spreadsheets. As the fixed income landscape has changed, the effort to ingest, validate and process data has increased significantly, leading many fixed income asset managers to look for more sophisticated data management solutions.

While deploying a combination of third party and internally built systems and tools have become commonplace for asset managers, the surplus of traditional and alternative data sources can overwhelm a fixed income desk.

Our next piece will explore the two primary approaches to building out a technology system where we provide criteria to help managers evaluate their current technology systems and consider the appropriate strategies to support their operating models.

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