Hedge Funds: Asset Coverage

Date: September 26, 2014

While seeking enhanced returns, hedge funds typically employ the use of derivatives across various asset classes. 

The ever expanding list of derivatives has always presented challenges to vendors in analytics, data-flow and support. The increasing reporting demands and regulatory prescriptions are adding additional pressure: for instance, European Union has regulated the Hedge Fund landscape, launching in 2014 the AIFMD regulation. This regulation opens the entire EU market to Hedge Funds, provided that they comply with precise risk management rules, whose complexity and sophistication increases proportionally to the complexity of the instruments and the investment strategies used by these Funds.

When translated to Risk Management solutions, the key question is how to get a flexible risk and analytics framework able to cover derivatives and structured products that may not have even been invented yet?

In StatPro, we have answered to this need by adopting a sophisticated and comprehensive Historical Simulation model, resting on a wide set of financial pricing libraries, covering already hundreds of different pay-offs. StatPro is a specialist of pricing derivatives, having created in 2000 the open-source project called QuantLib: today QuantLib is the most used library of financial pricing functions in the world. StatPro continuously develops new pricing functions, following clients requests and financial markets’ evolution. The flexibility of our environment empowers us to respond to the demands of our Hedge Fund clients, satisfying their need of coverage and capturing the complexity behind their strategies and portfolios.

Let’s look at an example of our pricing function development. Many of our clients had asked us to cover the CBOX volatility index (Vix) related products, more specifically Vix Futures, Vix Option and Vix Futures Option. The Vix index does not behave as a ‘normal’ index and therefore needed a complete new model in order to correctly calculate risk. Our quantitative development team reviewed the pay-off structures of these products in relation to the Vix and determined the additional framework that was need in both the index data as well as the pricing functions. The Vix Options and Futures Option are now priced using a Black formula where the forward price of the Vix Index or Vix Futures is evaluated using the VixFutures model. The complexity of this work and necessary testing spanned over a quarter and was delivered to production and is now in use.

Coverage is also an essential part of the AIFMD regulation. This regulation requires that Hedge Funds compute what is called “Commitment Exposure”. You can see the latter as a sort of option-adjusted exposure if you want, surrounded by many ‘special’ rules of netting and hedging that make the calculation of this number particularly challenging when derivatives are taken into consideration.

StatPro has released in early 2014 a new module of StatPro Revolution, his flagship portfolio analytics solution, able to compute AIFMD’s Commitment Exposure, in strict observation with European rules.

Asset coverage will always remain challenging as new derivatives emerge but StatPro is confident that we have the expertise and tools to keep pace. Our global network of offices provides exposure to all markets and has always added value to our clients by ensuring we have wide, global coverage. Revolution comes not only with the tools, but also with the support of performance & risk consultants, and behind the scenes, of developers, quantitative developers, data and technology teams.

Find out more about the changing hedge fund environment with our Hedge Fund Technology resource page.

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