Loan advice

A recent study by The Intertek Group tried to assess how the use of financial modeling in asset management had changed over the highly volatile period from 2000 to 2002. Participants in the study included 44 heads of asset management firms in Europe and North America; more than half were from the biggest firms in their home markets.
The study found that the role of quantitative methods in the investment decision-making process had increased at almost 75% of the firms while it had remained stable at about 15% of the firms; five reported that their process was already essentially quantitative. Demand pull and management push were among the reasons cited for the growing role of models. The head of risk management and product control at an international firm said, “There is genuinely a portfolio manager demand pull plus a top-down management push for a more systematic, robust process.” Many reported that fund managers have become more eager consumers of modeling. “Fund managers now perceive that they gain increased insights from the models,” the head of quantitative research at a large northern European firm commented.
In another finding, over one half of the participants evaluated that models had performed better in 2002 than two years ago; some 20% evaluated 2002 model performance to be stable with respect to the previous two years while another 20% considered that performance worsened. Performance was widely considered to be model-dependent. Among those that believed that model performance had improved, many attributed better performance to a better understanding of models and the modeling process at asset management firms. Some firms reported having in place a formal process in which management was systematically trained in modeling and mathematical methods.
The search for a silver bullet typical of the early days of “rocket science” in finance has passed; modeling is now widely perceived as an approximation, with the various models shedding different light on the same phenomena. Just under 60% of the participants in the 2002 study indicated having made significant changes to their modeling approach from 2000 to 2002; for many others, it was a question of continuously recalibrating and adapting the models to the changing environment.
Much of the recent attention on quantitative methods has been focused on risk management—a relatively new function at asset management firms. More than 80% of the firms participating in the Intertek study reported a significant evolution of the role of risk management from 2000 to 2002. Some of the trends revealed by the study included daily or real-time risk measurement and the splitting of the role of risk management into two separate functions, one a support function to the fund managers, the other a central control function reporting to top management.
In another area which is a measure of an increasingly systematic process, more than 60% of the firms in the 2002 study reported having formalized procedures for integrating quantitative and qualitative input, though half mentioned that the process had not gone very far and 30% reported no formalization at all. One way the integration is being handled is through management structures for decision-making. A source at a large player in the bond market said, “We have regularly scheduled meetings where views are expressed. There is a good combination of views and numbers crunched. The mix between quantitative and qualitative input will depend on the particular situation. For example, if models are showing a 4 or 5 standard deviation event, fundamental analysis would have to be very strong before overriding the models.”
Many firms have cast integration in a quantitative framework. The head of research at a large European firm said, “One year ago, the integration was totally fuzzy, but during the past year we have made the integration extremely rigorous. All managers now need to justify their statements and methods in a quantitative sense.” Some firms are prioritizing the inputs from various sources. A business manager at a Swiss firm said, “We have recently put in place a scoring framework which pulls together the gut feeling of the fund manager and the quantitative models. We will be taking this further. The objective is to more tightly link the various inputs, be they judgmental or model results.”
Some firms see the problem as one of model performance evaluation. “The integration process is becoming more and more institutionalized,” said the head of quantitative research at a big northern European firm. “Models are weighted in terms of their performance: if a model has not performed so well, its output is less influential than that of mod- els which have performed better.”
In some cases, it is the portfolio manager himself who assigns weights to the various inputs. A source at a large firm active in the bond markets said, “Portfolio managers weight the relative importance of quantitative and qualitative input in function of the security. The more complex the security, the greater the quantitative weighting; the more macro, long-term, the less the quantitative input counts: Models don’t really help here.” Other firms have a fixed percentage, such as 50/50, as corporate policy. Outside of quantitatively run funds, the feeling is that there is a weight limit in the range of 60–80% for quantitative input. “There will always be a technical and a tactical element,” said one source.
Virtually all firms reported a partial automation in the handling of qualitative information, with some 30% planning to add functionality over and above the filtering and search functionality now typically provided by the suppliers of analyst research, consensus data and news. About 25% of the participants said that they would further automate the handling of information in 2003. The automatic summarization and analysis of news and other information available electronically was the next step for several firms that had already largely automated the investment process.