A Pain in the Back Office
“I’m only a trade away from a problem.”
If you’re managing a substantial backroom operation, that statement probably sends shivers down your spine. Derivatives and other complex investments are important portfolio assets for institutional investors. But they entail a constant game of “who’s on first?”
If you’re trading for yield, you need new investment vehicles — like interest rate swaps, credit default swaps, bank loans, private placements, inflation indexed bonds, currency options, bond futures, commercial mortgage-backed securities, and more — and they can be tough on the back office because they’re hard to keep track of.
Investment departments used to put their funds into Treasuries, T-bills, stocks, and corporate or municipal bonds. All had predictable returns, and systems were designed to keep track of them. But if a product requires floating interest rates, externally-modelled cash-flows, etc., it’s a whole new ballgame. You have to track variable rates, foreign currency rates, and the underlying credit risks. If you’re not careful, it can be a mess.
If you don’t set it up correctly at the beginning, you may learn when the cash comes in that the income you forecasted does not equal the income you receive. This means someone has to reconcile the difference. And if one accounting regulation requires you to report something as a bond, while another says you need to call it something else, the back office could end up in a real tizzy.
Companies with assets of $50 billion or more choose these complex investment vehicles because of the great yields they can produce. Since a few basis points make a big difference to their clients, they have to be good at it. As a result, they may have several hundred of these investments. If so, keeping track of them with older software or spreadsheets may not be viable.
Many companies believe their current software can provide the necessary functionality to make these investments manageable. But even if the software includes a patch intended to handle them, it may take a year or two to get it into production — and it still may not be adequate.
Vendors, too, can be overwhelmed with the new products as their clients demand solutions for processing, accounting, and reporting for these instruments as they invest in them.. So, they’re likely trying to keep up. And since they only release new versions of their software once a year, each release has to be tested. Best case? A company in desperate need of a system to handle complex investment types is often a year or more away from getting it into production.
It may be prudent to acquire a temporary system to manage only alternative investments, at least until the existing system can accommodate them. Think of it as a bridge that safely gets you to the other side, carrying you over the turbulent waters of alternative investments.
At the very least, it’ll spare you a pain in the back office.
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