White Paper
Build or Buy Risk System: Lessons from Acquiring a House
Two important characteristics defining the alternative investment environment today are the continuously growing competition for investors' funds and elevated skepticism. Both have had a significant impact on the efforts by hedge funds of all sizes to acquire the sustainable competitive advantages that would put them ahead of the array of other investment opportunities. Implementation of the institutional level infrastructure has become imperative for the money managers who want to demonstrate their diligence to their prospects. Since risk management system has always been an important part of the infrastructure, the question "Why to have risk management system?" has been replaced by the question "Buy or Build Risk Management System?"
Deciding on a way to properly set up the risk management practices, a money manager has several options: purchase pre-packaged risk software, engage in the internal risk system building, or subcontract the project to outside vendors such as Bluefront Capital. The easiest way to analyze the pros and cons of any of these options is to compare them to the different methods of acquiring a house. Similar to risk systems, you can buy a house, build it yourself, or hire the construction workers to build it for you. Which way you choose will depend on time availability, level of your competence in construction, your financial resources, desired house customization and control over the process, as well as the subsequent house maintenance and repair. Once you have analyzed these issues, the best way to acquire a house becomes clear. Addressing the problems with regards to risk management will direct you towards building, buying, or subcontracting the systems.
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Time Availability
Being the scarcest resource, time often becomes the deciding factor when you set out to get a house. If you had an eternity in your hands, you would take time to enjoy and appreciate the building of your shelter. However, since other missions in life cannot wait, you try to estimate whether the building of a house can be completed in the foreseeable future, either on your own or with the help of experts. Time being of the essence, you can shorten the building process by inviting your father-in-law to help on weekends or by hiring more workers perform more work per day. Alternatively, if you need a place to live immediately and some good enough solutions are available on the market, you might just buy a ready-to-go house and concentrate on other activities in your life.
Analogically, a diligent investment process rarely allows for a lot of slack. So the money manager who wants to have risk systems built internally needs to reorganize the process and often deprive himself of sleep to devote some hours to studying the issue and training the personnel. Newly hired risk professionals can add hours directed towards the development of the risk system at the expense of the increased payroll and decreased office space. In contrast, service providers with already established teams of risk experts will do the job for a flat fee and will not occupy your office space. But if you cannot wait to demonstrate your investors the level of prudence that you achieved with your process, you may purchase the pre-packaged risk software and use it the same day.
----------------------------------------------------------------------------------------------------------------------------
Competence
The analysis of time limitations is inseparable from the issue of the expertise in hand. If there is a lack of expertise, would the process of its acquiring fit into the time window available for that? If you decided to build your own house, you better know the nuts and bolts of construction, from building the foundation to setting up the plumbing. However, if your toilet fixing ability is not as good as your designing skills, would you have to pass the work to your grand children to finish it? If you are quite satisfied with your job as a portfolio manager and learning the craft of the house building is not a part of your dream, you might go for the specialized construction workers who will fix up the issues in the short time or simply buy a house.
The same goes for the risk systems. The changes in the investment and regulatory environment require that money managers acquire the necessary level of expertise very quickly. If you are fortunate to have a previous experience with risk systems, building them internally may become the optimal solution. The insider knowledge of the investment strategy combined with the knowledge of the best risk practices would result in the most insightful risk system, fully fitting into your strategy. However, if your expertise is focused on the management of the portfolio, diverting time and energy from it may harm the performance and become costly. In this case, subcontracting the work or buying the ready-to-go risk software may become handy.
----------------------------------------------------------------------------------------------------------------------------
Financial Resources
When you assessed the time availability and the level of your expertise, you need to evaluate your financial resources. You might possess the perfect ability to learn how to install the doors, but you also have enough money to purchase a house with the doors installed. Conversely, you may have issues with the piles of bricks on your backyard and construction workers interrupting your quiet life, but, since the money is limited, you have to put up with the temporary discomfort. As the purchase of a house always puts a significant stress on the future home-owner's finances, building a house or hiring the workers might allow for the incremental expenses spread out in time.
Similarly, buying risk management software most often requires spending a one-time lump sum, whereas building or subcontracting may entail a set of smaller incremental expenses separated in time. For example, building the internal risk system can require attending the training sessions, allocating computers and software, and acquiring the necessary advice. Subcontracting, involving various levels of services, from building a basic risk model to developing a one-of-a-kind risk system, can be split into the set of payments for particular services, lifting the pressure of a one time large expense.
Additionally, when you are buying a house, the higher the initial price means more room for bidding it down. Bargaining is more tedious if you want to build a house on your own, since you will have to negotiate the price of every material that you purchase. Finally, if the workers build your house, you are more likely to get a favorable deal if, together with your house, they will fix up your garage, your driveway, and get good referrals to your neighbors.
The same applies to negotiations about the risk systems. If you acquire the pre-packaged software, the higher the dollar value of your purchase, the more discount the software developer would be willing to give. Building the system internally is not an easy bargain as your traders will be unlikely to work extra hours for less money in order to develop the risk system for you. Conversely, as service vendors engage into a specter of interrelated services (such as risk management, risk marketing, and risk reporting), the more services you want from them or the more business you refer to them, the more prone they are to lower the price.
----------------------------------------------------------------------------------------------------------------------------
Customization
If you want your house to be like every other in the neighborhood, then shopping for one would probably be the best idea. Building it on your own may quadruple the amount of time you would need. Furthermore, somewhere half way, you might realize that you are not capable of finishing at all and since the time has passed, the needs have already changed. In this case, to turn to the construction experts might be your smartest move.
Analogically, a straightforward investment process might benefit from the standard risk management software. Standard packages with the pre-set risk metrics would harmoniously fit into the process and create no additional complications. However, if the functionality of the pre-packaged software does not fully reflect the complexity of your investment vehicles, internal building or outsourcing might be the best solution. The success of the former would ultimately depend on the level of the expertise mentioned earlier. In the latter, service vendor firms often have the experts ready to design any sophistication of a risk model provided it is properly communicated.
----------------------------------------------------------------------------------------------------------------------------
Security
If you cannot entrust your house to others, you might need to surround yourself with "Construction Zone" signs to keep the outsiders out. You may as well invent your own alarm system that would protect you from the uninvited guests. Unlike the vulnerable standard alarm systems that come with the purchased house, your own system can be protect you from the intruders the way you want it to.
Hiring people to build your house inevitably means the temporary loss of your sovereignty: the workers will be around for a while, interrupting your daily activities. You might want to keep an eye on that antique furniture. Moreover, since they know about that secret room in your house, you need to ensure that they will not visit it without your knowledge in the future.
Building the risk system internally is the safest from the proprietary perspective. You do not have to disclose anyone how and why you invest and what miracle you do to make the money grow. Buying the risk system carries the same benefits; however, the need to deal with the customer service and the standard protection mechanisms may lead to some information leak.
On the other hand, dealing with the service vendors would ultimately mean allowing them to witness the inner world of your investment process. Development of the well-rounded Nondisclosure Agreement becomes crucial. How information on your investment process is stored, handled, and used needs to be addressed and clearly communicated. Furthermore, you might want to know what happens to the blueprint of the risk model developed for you. It may make a difference if, instead of becoming your property, the model is used for the next client.
----------------------------------------------------------------------------------------------------------------------------
Repair and Maintenance
The way you choose to acquire the house will have an effect even after you moved in. What if the house collapses the second day you bought it? Who will fix the roof that cannot withstand the rain? Will those construction workers come back and redo the job? Regardless of how you acquired the house, the proper maintenance and repair insurance in place will make your life much easier. You want the problem to be fixed in the shortest time and with the least damage to your budget.
The pre-packaged systems often do come with the warranty periods. What you need to make sure of is that, if the trouble happens late in the evening, you will not need to talk to the automatic responder for a few hours. Building the systems yourself frees you from the need to deal with the robotic customer service, however, puts the entire burden on your shoulders. Finally, if vendors built your system, encountering a trouble with your risk system might let you see their true colors. Smaller vendors, as they viciously compete for new clients, will be more prone to provide a timely and individualized troubleshooting and updating. So careful writing of the contract might save you from the future headaches. If the vendors promise personalized service 24/7, that is what you need to expect.
----------------------------------------------------------------------------------------------------------------------------
Conclusion
Analyzing the issues of time availability, competency, finances, customization, security, maintenance, and troubleshooting with regards to risk management system, you can really choose which method of its acquisition is more appropriate for you.
If you have a lot of resources and experience in hand and also care about security and flexibility of the system, you are better off building it in-house. If you lack the resources and still require the unique risk system, vendors can be the best solution. Pay special attention on security and maintenance arrangements. If you want to solve the problem quickly and have no special requests for the system, the easiest would be to go with the existing standardized solutions provided they offer competitive pricing and decent customer service.
Lastly, you may ask, "Why to own a house while I can rent it?" Can you "rent" a risk management system? Absolutely! Without having the risk system and risk professionals under your roof, you can still get the full benefits of monitoring and analysis of your key risk metrics. Nowadays, many service vendors can perform the complete analysis of your portfolio, create your risk profile, and incorporate it into your reporting system with the desired frequency. Together with saving your time and money, third party risk reports will also provide the investors the reassurance on the diligence of your investment process. Information security and customization of the vendor's approach are important to derive the maximum value with the minimum expenses.
Two important characteristics defining the alternative investment environment today are the continuously growing competition for investors' funds and elevated skepticism. Both have had a significant impact on the efforts by hedge funds of all sizes to acquire the sustainable competitive advantages that would put them ahead of the array of other investment opportunities. Implementation of the institutional level infrastructure has become imperative for the money managers who want to demonstrate their diligence to their prospects. Since risk management system has always been an important part of the infrastructure, the question "Why to have risk management system?" has been replaced by the question "Buy or Build Risk Management System?"
Deciding on a way to properly set up the risk management practices, a money manager has several options: purchase pre-packaged risk software, engage in the internal risk system building, or subcontract the project to outside vendors such as Bluefront Capital. The easiest way to analyze the pros and cons of any of these options is to compare them to the different methods of acquiring a house. Similar to risk systems, you can buy a house, build it yourself, or hire the construction workers to build it for you. Which way you choose will depend on time availability, level of your competence in construction, your financial resources, desired house customization and control over the process, as well as the subsequent house maintenance and repair. Once you have analyzed these issues, the best way to acquire a house becomes clear. Addressing the problems with regards to risk management will direct you towards building, buying, or subcontracting the systems.
----------------------------------------------------------------------------------------------------------------------------
Time Availability
Being the scarcest resource, time often becomes the deciding factor when you set out to get a house. If you had an eternity in your hands, you would take time to enjoy and appreciate the building of your shelter. However, since other missions in life cannot wait, you try to estimate whether the building of a house can be completed in the foreseeable future, either on your own or with the help of experts. Time being of the essence, you can shorten the building process by inviting your father-in-law to help on weekends or by hiring more workers perform more work per day. Alternatively, if you need a place to live immediately and some good enough solutions are available on the market, you might just buy a ready-to-go house and concentrate on other activities in your life.
Analogically, a diligent investment process rarely allows for a lot of slack. So the money manager who wants to have risk systems built internally needs to reorganize the process and often deprive himself of sleep to devote some hours to studying the issue and training the personnel. Newly hired risk professionals can add hours directed towards the development of the risk system at the expense of the increased payroll and decreased office space. In contrast, service providers with already established teams of risk experts will do the job for a flat fee and will not occupy your office space. But if you cannot wait to demonstrate your investors the level of prudence that you achieved with your process, you may purchase the pre-packaged risk software and use it the same day.
----------------------------------------------------------------------------------------------------------------------------
Competence
The analysis of time limitations is inseparable from the issue of the expertise in hand. If there is a lack of expertise, would the process of its acquiring fit into the time window available for that? If you decided to build your own house, you better know the nuts and bolts of construction, from building the foundation to setting up the plumbing. However, if your toilet fixing ability is not as good as your designing skills, would you have to pass the work to your grand children to finish it? If you are quite satisfied with your job as a portfolio manager and learning the craft of the house building is not a part of your dream, you might go for the specialized construction workers who will fix up the issues in the short time or simply buy a house.
The same goes for the risk systems. The changes in the investment and regulatory environment require that money managers acquire the necessary level of expertise very quickly. If you are fortunate to have a previous experience with risk systems, building them internally may become the optimal solution. The insider knowledge of the investment strategy combined with the knowledge of the best risk practices would result in the most insightful risk system, fully fitting into your strategy. However, if your expertise is focused on the management of the portfolio, diverting time and energy from it may harm the performance and become costly. In this case, subcontracting the work or buying the ready-to-go risk software may become handy.
----------------------------------------------------------------------------------------------------------------------------
Financial Resources
When you assessed the time availability and the level of your expertise, you need to evaluate your financial resources. You might possess the perfect ability to learn how to install the doors, but you also have enough money to purchase a house with the doors installed. Conversely, you may have issues with the piles of bricks on your backyard and construction workers interrupting your quiet life, but, since the money is limited, you have to put up with the temporary discomfort. As the purchase of a house always puts a significant stress on the future home-owner's finances, building a house or hiring the workers might allow for the incremental expenses spread out in time.
Similarly, buying risk management software most often requires spending a one-time lump sum, whereas building or subcontracting may entail a set of smaller incremental expenses separated in time. For example, building the internal risk system can require attending the training sessions, allocating computers and software, and acquiring the necessary advice. Subcontracting, involving various levels of services, from building a basic risk model to developing a one-of-a-kind risk system, can be split into the set of payments for particular services, lifting the pressure of a one time large expense.
Additionally, when you are buying a house, the higher the initial price means more room for bidding it down. Bargaining is more tedious if you want to build a house on your own, since you will have to negotiate the price of every material that you purchase. Finally, if the workers build your house, you are more likely to get a favorable deal if, together with your house, they will fix up your garage, your driveway, and get good referrals to your neighbors.
The same applies to negotiations about the risk systems. If you acquire the pre-packaged software, the higher the dollar value of your purchase, the more discount the software developer would be willing to give. Building the system internally is not an easy bargain as your traders will be unlikely to work extra hours for less money in order to develop the risk system for you. Conversely, as service vendors engage into a specter of interrelated services (such as risk management, risk marketing, and risk reporting), the more services you want from them or the more business you refer to them, the more prone they are to lower the price.
----------------------------------------------------------------------------------------------------------------------------
Customization
If you want your house to be like every other in the neighborhood, then shopping for one would probably be the best idea. Building it on your own may quadruple the amount of time you would need. Furthermore, somewhere half way, you might realize that you are not capable of finishing at all and since the time has passed, the needs have already changed. In this case, to turn to the construction experts might be your smartest move.
Analogically, a straightforward investment process might benefit from the standard risk management software. Standard packages with the pre-set risk metrics would harmoniously fit into the process and create no additional complications. However, if the functionality of the pre-packaged software does not fully reflect the complexity of your investment vehicles, internal building or outsourcing might be the best solution. The success of the former would ultimately depend on the level of the expertise mentioned earlier. In the latter, service vendor firms often have the experts ready to design any sophistication of a risk model provided it is properly communicated.
----------------------------------------------------------------------------------------------------------------------------
Security
If you cannot entrust your house to others, you might need to surround yourself with "Construction Zone" signs to keep the outsiders out. You may as well invent your own alarm system that would protect you from the uninvited guests. Unlike the vulnerable standard alarm systems that come with the purchased house, your own system can be protect you from the intruders the way you want it to.
Hiring people to build your house inevitably means the temporary loss of your sovereignty: the workers will be around for a while, interrupting your daily activities. You might want to keep an eye on that antique furniture. Moreover, since they know about that secret room in your house, you need to ensure that they will not visit it without your knowledge in the future.
Building the risk system internally is the safest from the proprietary perspective. You do not have to disclose anyone how and why you invest and what miracle you do to make the money grow. Buying the risk system carries the same benefits; however, the need to deal with the customer service and the standard protection mechanisms may lead to some information leak.
On the other hand, dealing with the service vendors would ultimately mean allowing them to witness the inner world of your investment process. Development of the well-rounded Nondisclosure Agreement becomes crucial. How information on your investment process is stored, handled, and used needs to be addressed and clearly communicated. Furthermore, you might want to know what happens to the blueprint of the risk model developed for you. It may make a difference if, instead of becoming your property, the model is used for the next client.
----------------------------------------------------------------------------------------------------------------------------
Repair and Maintenance
The way you choose to acquire the house will have an effect even after you moved in. What if the house collapses the second day you bought it? Who will fix the roof that cannot withstand the rain? Will those construction workers come back and redo the job? Regardless of how you acquired the house, the proper maintenance and repair insurance in place will make your life much easier. You want the problem to be fixed in the shortest time and with the least damage to your budget.
The pre-packaged systems often do come with the warranty periods. What you need to make sure of is that, if the trouble happens late in the evening, you will not need to talk to the automatic responder for a few hours. Building the systems yourself frees you from the need to deal with the robotic customer service, however, puts the entire burden on your shoulders. Finally, if vendors built your system, encountering a trouble with your risk system might let you see their true colors. Smaller vendors, as they viciously compete for new clients, will be more prone to provide a timely and individualized troubleshooting and updating. So careful writing of the contract might save you from the future headaches. If the vendors promise personalized service 24/7, that is what you need to expect.
----------------------------------------------------------------------------------------------------------------------------
Conclusion
Analyzing the issues of time availability, competency, finances, customization, security, maintenance, and troubleshooting with regards to risk management system, you can really choose which method of its acquisition is more appropriate for you.
If you have a lot of resources and experience in hand and also care about security and flexibility of the system, you are better off building it in-house. If you lack the resources and still require the unique risk system, vendors can be the best solution. Pay special attention on security and maintenance arrangements. If you want to solve the problem quickly and have no special requests for the system, the easiest would be to go with the existing standardized solutions provided they offer competitive pricing and decent customer service.
Lastly, you may ask, "Why to own a house while I can rent it?" Can you "rent" a risk management system? Absolutely! Without having the risk system and risk professionals under your roof, you can still get the full benefits of monitoring and analysis of your key risk metrics. Nowadays, many service vendors can perform the complete analysis of your portfolio, create your risk profile, and incorporate it into your reporting system with the desired frequency. Together with saving your time and money, third party risk reports will also provide the investors the reassurance on the diligence of your investment process. Information security and customization of the vendor's approach are important to derive the maximum value with the minimum expenses.
