Friday, November 25, 2011

Analytics in Financial Services

The financial industry usually thinks of analytics in terms of models, pricing and risk metrics. However, at last week's Hedge Fund Conference in Singapore, people were talking about more strategic applications.

Transaction Cost Analysis
Funds are becoming increasingly interested in the difference in price between the moment the manager makes a decision to trade and the actual price at time of execution. Part of the difference will be commission, taxes and the like but part is also due to movements in the market in the time taken to trade. This slippage has a direct impact on the performance of the fund.

Funds can use this information to select a preferred broker and to also negotiate fees with brokers. As the markets continue to look uninspiring, this type of analysis could become increasingly useful for the investment industry.

Counterparty Analytics (2nd order and greater)
Funds already undertake counterparty risk analysis to ensure they are not overly exposed to one particular entity. However, each entity is, of course, exposed to other entities itself. Investors are keen for a way to examine data to understand their true exposure to a counterparty. Somewhat like Six Degrees of Kevin Bacon.

For example, if Investor ABC holds bonds issued by companies DEF and GHI, but DEF also holds bonds issued by company GHI, then ABC's exposure to GHI may be more than they expect.

This, of course, is not limited solely to financial services or counter parties. Companies across the board might have unwitting exposure to all sorts of counter parties, industries, commodities, currencies and so on.

The finance industry has always led the way in Analytics, due to its spending power, culture and human capital. We'll see analytics like this play an increasingly larger role as the double-dip continues to dominate the headlines.

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