This time last year, markets globally were in the throes of the “meme stock” storm and a surge in crypto markets that left many heads spinning – and many asset managers trying to figure out what exactly they could do to ride the waves of this shifting tide.
2022 so far has painted a much different picture.
Inflation, Invasion, and Uncertainty
Rapidly rising inflation had been a worry for managers around the world since the latter half of 2021, coming to a fever pitch when the latest CPI numbers revealed that consumer prices had jumped more than 8.5% over the past 12 months – the most in four decades. But what seemed to be the key market-moving event of the year quickly faded into the background in late February, with the Russian invasion of Ukraine. Significant sanctions on Russian oil and other commodities have triggered a steep and rapid rise in global energy prices and supply chain disruptions.
Markets have, unsurprisingly, reflected a high-degree of uncertainty over recent weeks, as more sanctions come into effect and their impacts start to materialize into real changes to energy pricing. Managers are left with incredibly volatile markets and signals that the broader economic ecosystem is more likely to deteriorate further before any sustained recovery. Signals that they simply cannot ignore.
Modeling and Assessing Risk
Those who have navigated the past few months even relatively unscathed can count themselves lucky, but managers of all stripes need to re-evaluate how they are modeling and assessing risk in the face of what could be the biggest and most sustained downturn in markets in several years.
Taking it one step further, managers should be looking not just at their modeling, but at the underlying systems and technology that run their models. What we know for sure is that the current set of black-box and even tailored technology solutions have never really had to factor in global risk on this scale.
Traditional inflation-proof investment theses such as overweight gold, commodities or REITs should ideally be tested against current holdings, looking for diversification benefits and outright performance of the asset class. Does the new portfolio perform better in a stress scenario? Does it reduce volatility? Which FX exposures might be magnified in a broad inflation backdrop?
Increasing Capacity and Flexibility
Testing is the operative word here. It’s hardly enough to make trades on forecasts alone, clearly evidenced by the disparities between inflation forecasts from late 2021 to our present-day predicament.
Backtesting against historical scenarios is one way, or alternatively (ideally additionally), adding trades to a portfolio and running VaR and scenario simulations across a range of time-frames. There is no shortage of historical data to draw on for periods of general volatility, and even periods of extended inflation. However, in the present-day scenario, managers are tasked with deciphering the impact of the conflict in Ukraine on what were already fairly volatile markets – and finding scenarios to run that can account for both.
More than anything, the focus needs to be on structural flexibility, meaning technology that is capable of pivoting, adapting and reacting to rapidly changing circumstances. Managers need the ability to run scenarios through a significant volume of historical data – and quickly. The question then becomes, can legacy systems keep up with the current rate of change in the markets.
Leveraging the Cloud for Innovation
As the search for yield and alpha gets tougher, managers will need to lean on innovation to bring themselves ahead of the competition. But innovation is harder to come by when operating in a rigid silo. Moving to a cloud-based system can significantly boost a firm’s capabilities for innovating or implementing new instruments into the system, developing and testing new models, or making better use of siloed skills and resources.
Elastic cloud infrastructure ultimately ensures firms have the ability to assess new situations, run tests on new models, and implement effective solutions, at scale, quicker than they would be able to on any server-based or legacy system. These modern platforms boost the firm’s flexibility, enabling a more customized approach that can be scaled and improved upon more rapidly than either a black box or an internal build.
These elastic-cloud systems can handle and process larger volumes of data, faster, adding a further element of adaptability. The ability to flexibly ingest and interrogate new data, looking for causal relationships with the markets, is an edge for the leading traders and risk-warehousing firms.
Acting and Reacting Faster With Better Information
If capital markets have taught us anything over the past 12 months, it’s that those who have been able to react the fastest have been in the best position to come out on top. In an environment where yield is getting harder to come by, and pressure is coming from clients who are anxious about their portfolio’s performance, it’s impossible to understate the value of a system that’s capable of producing actionable results as quickly as possible.
Looking into 2022, managers will need to look holistically at their systems, and truly evaluate whether or not they’re capable of keeping up with several more months, at least, of volatility and uncertainty on the scale we’ve seen so far this year.
If the answer is no, they will need to act fast, or risk getting left behind.