Real Risk Valuation vs. Sexy Reports

There are two distinct trends in finance software applications: tools designed to provide a deep insight into the matter and products aimed to make impressions. The latter dominate the industry, thus opening an apparently naive question - why do investors need analytical tools and applications at all? To provide the basis for an investment decision, perhaps? Not always so.

The market is oversaturated by a huge range of analytical tools having one thing in common - a bias toward reports and presentations, while the core functionality and methodology of analyses become the last priority. Nowadays, nobody argues that hedge funds are unique beasts with unique properties and, therefore, require unique analytical tools. One may find hundreds of studies evidencing the non-normality of hedge fund distributions of returns and, as such, inapplicability of traditional approaches, for example, the mean-variance theory. There are tons of references to numerous biases of hedge fund indices, which, in turn, lead to uselessness of the entire Tactical Asset Allocation framework. So, why do the major market players ignore all that?

The answers are not so obvious and, for sure, will be hated by many:

1. Many institutions use investment analytics only to address two needs:

  • To comply with the industry standards and pass regulatory due diligence tests.
  • To make nice-looking reports for the senior management that often have vague understanding of the subject.

2. Institutions are still driven by wild incompetence, when it comes to alternative investments. For more discussions on that subject click here.

3. For software vendors, it is easier to incorporate tons of various report templates or add hundreds of useless statistics replicating the same information than drill into the core research methodology. It is not a secret that most vendors outsource their developments to the Third World countries. The only outcome one can get from this, if any at all, is technical programming, which is not enough to create sophisticated analytics. Unfortunately, this common practice represents a devastating global trend across many industries, when making a quick profit becomes the only priority.

4. For years, institutions invested into top institutional hedge funds with low volatility, thus creating an enormous web of cross-investments. This, in turn, resulted in a higher correlation across the board, thus making fund selection relatively irrelevant. In other words, it doesn’t really matter - in what institutional fund to invest, the portfolio performance will be more or less the same. Obviously, such investment decisions do not require a solid risk assessment, therefore, making the reporting part most important.

5. Generating thick (one-click) reports makes an illusion of titanic work of investment analysts. It is a highly desirable feature for many mediocre advisers with no viable expertise in the subject. We happen to know institutions employing former police officers or bachelors of Fine Arts (no finance background as such!) as investment analysts. Should we expect these 'experts' to value anything except impressive, but shallow reports? Probably, not.

So, where does this problem leave a hedge fund investor when choosing a right application framework? The answer is simple. If you need sexy-looking 3D charts to impress your boss, go after any platform focusing on reports as the key requirement. If, however, you are after a deep and unbiased insight into hedge fund risks, take a closer look at what is inside, whether the employed methodology could be applied to your assets. Very simple.

Tagged under
We use cookies to improve our website. By continuing to use this website, you are giving consent to cookies being used. More details…