Risk Management

The Time Weighted Rate of Return (TWRR) allows the valuation of the actual performance of the management of a portfolio, sterilizing (as occurs in the calculation of the Investment Fund Shares certificates value) the distortive effect of investment and de-investment flows. The grouping criteria for the calculation can be freely established by the user, who can analyze the performance of:

• an entire portfolio
  single holdings
  MetaAssets made up of holdings belonging to one or more portfolios

The launch of the TWRR calculation and the calculation itself can be automated through a macro planned with the desired frequency. To each holding group object of the TWRR calculation it is possible to link a benchmark (a market index or a benchmark composed ad hoc) and an asset without risk. This allows the user to place together side by side measures of yield, risk, relative performance and risk-adjusted performance, among which are:

• average yield
  money weighted Rate of Return
  ·volatility
  Sharpe index
  Sortino index
  tracking error and tracking error volatility
  beta, Jensen’s Performance Index and their standard deviations

An essential requirement for the TWRR calculation is the availability of a market value for each holding included in the valuation. In the cases of holdings on illiquid bonds or OTC derivatives, the valuation can be carried out using the Fair Price calculated by SimCorp Sofia. The Time Weighted Rate of Return module includes some Contribution analysis instruments; once the TWRR calculation macros have been launched it is possible to decompose the yield of each portfolio (or MetaAsset) in the sum of the contributions of holding subgroups. The analysis can be detailed even to a single holding.

For portfolios whose groups of holdings are object of the performance analysis, it is possible to analyze performance attribution, thus highlighting the effect of asset allocation and stock selection and therefore defining the determinants of excess return of the portfolio with respect to the benchmark.

The calculation functions of Fair Price for bonds and derivatives are the bases of these modules. The information necessary for the Fair Price calculation is retrieved from the data reference of each security (flows dates, indexation rules, discounting curves, etc.). The Fair Price calculated by SimCorp Sofia is written in the prices database and can be used for the valuation of holdings. When the calculation functions of the fair price are used by the VaR and Stress Test modules, market curves are substituted with simulated curves.

This module allows the analysis of the behavior of the portfolio in response to a market shock hypothesised by the user. Risk factors taken into consideration are: interest rates, market indices, FX rates and credit spread. Users can apply to the interest rate curves parallel shifts, tilts and twists. Each maturity of interest rates curve can be modified. The module supplies in output synthetic information about portfolio losses and analytical data regarding single holdings. The simulation engine is based upon a method of full re-pricing of the portfolio bonds and interest rates derivatives. This allows the construction of a set of fair prices of single instruments after the application of the hypothesized scenario. For the stress of share instruments it is possible to vary by percentage the prices of the market share indices through the calculation of historical beta.

It is also possible to vary the FX rates by considering the stress on FX rates of foreign currencies. Further supplementary functions allow, in addition to the valuation of the portfolio after the shock, the calculation of its future flows – holding by holding, indexing future coupons based on the scenario. Users can also conduct “What If” analyses, i.e. on portfolios hypothesized by the user and imported in SimCorp Sofia via simple Excel spreadsheets. The Stress Test module includes some calculation functions of the effective duration of bonds and interest rate derivatives.

Value at Risk (VaR) is available with both parametric and historical methods of calculation. This calculation can be applied to entire portfolios or MetaAssets chosen by the user. The parametric VaR is based on the standard RiskMetrics combined with the portfolio aggregation principle, this is the reason why computation of risk factors variance-covariance matrices is not needed, but time series of prices of securities in the portfolios are. In addition to VaR, SimCorp Sofia calculates other indicators such as Expected Shortfall, Marginal VaR and Incremental VaR of single holdings in respect to the MetaAssets they belong to.  

In addition to the traditional parametric Value at Risk model, a module for the calculation of the historical-simulation Value at Risk is available. This function allows users to value the potential loss of portfolios based upon the distribution of the losses of portfolio simulated on constructed scenarios. This is achieved by applying to risk factors the historical variations that occurred during the time period defined by the user. Compared to the parametric VaR method, the valuation of the value at risk is based upon the techniques of Stress test and on SimCorp Sofia Fair pricing engine.

In addition to VaR, SimCorp Sofia calculates other indicators such as Expected Shortfall, Marginal VaR and Incremental VaR for both single holdings and MetaAssets. Moreover, in case of VaR, it is possible to conduct “What If” analyses on external portfolios.