Pension executives worried about money managers violating investment guidelines are asking for - and getting - new electronic monitoring software to police their managers.
Some of the most wanted risk management system products coming from trust and custody banks are electronic icons or agents that blink on computer screens. They carry messages telling pension executives of money managers significantly exceeding investment guidelines.
The agents also give the first warnings that a pension fund's asset allocation is out of balance.
The newest monitoring software was just announced by Mellon Trust Co., Boston. The Northern Trust Co., Chicago, recently released a new version of its monitoring or agent software. State Street Bank & Trust Co., Boston, has just put in limited release its monitoring software. Bank of New York will release a monitoring program soon.
Exploratory talks also are being held between risk measurement consultant BARRA Inc., Berkeley, Calif., and two trust and custody banks, which BARRA officials wouldn't identify. They're discussing plans to strengthen monitoring agents so they would be able to recognize not only what investment guidelines have been violated, but also what level of risk is being taken with how much money.
In addition, risk analysis consultant and software vendor Capital Management Sciences, Los Angeles, just released a compliance module in its risk measurement and analytical software product, BondEdge for Windows.
Monitoring is a hot product
Monitoring programs "are the hottest products in the industry. They have really triggered a nerve because of what is happening," said Eliza Spain, a senior vice president at Northern Trust. She was referring to concerns about large portfolio losses some investors have suffered.
One bank executive who didn't want to be identified encourages demand for the monitoring software by telling his clients the product will help them steer clear of bad publicity.
"It will keep you off '60 Minutes'," he promises.
Tom Pollihan, manager of pension finance at the $2 billion-plus Ralston Purina Co. pension fund, St. Louis, is one of the first users of Northern Trust's surveillance agent, called Alert.
"These tools that Northern Trust is developing should become some of the most important products of a global custodian bank. Effective development and roll-out of them will make a global electronic safety net which I can use to monitor and manage risk," Mr. Pollihan said.
An estimated 25 plans are using or testing the banks' monitoring software now. But bank executives expect several hundred mostly large pension funds ultimately will use it.
At the $14.6 billion Pacific Telesis Group pension fund, San Francisco, executives are awaiting a demonstration of Mellon Trust's monitoring program, Investment Monitor, said William Malet, manager of investment administration.
He said four other pension funds he wouldn't identify - whose executives originally asked for the product - are being used as test sites for the Mellon program.
'First line of defense'
"Right now these (monitoring programs) are the first line of defense in checking out what is going on," said James J. Darr, an executive vice president and director of U.S. financial asset services at State Street Bank. His bank's product is called Investment Policy Monitor.
"These things, I suspect, are going to get much more sophisticated over the next year or two," he said.
Added Lisa Baker-Stanton, director of sponsor services at BARRA: "The master trust banks are in the best position to provide this (monitoring) information. They have all the information and know on a daily, even an hourly, basis what the (pension fund) holdings are."
The agents can, among other things:
Quickly spot if a money manager is trying to make his performance goals by taking excessive risks.
Identify managers using derivatives that aren't allowed.
Alert a pension executive if his portfolio in the aggregate has exceeded the appropriate level of company stock or is too heavily weighted in another company's stock or a particular industry.
Identify if a money manager has a greater percentage of assets than is permitted in a particular country.
Spot if a pension fund's counterparty exposure is too great with a particular broker.
Warn if an investment has been made in so-called sin stocks or social investments that aren't allowed.
Clients clamor for the help
Trust and custody banks are providing the monitoring software at the behest of pension funds and other institutional investors that increasingly are interested in risk management.
Corporate pension officers are under pressure from boards of directors to make sure their companies don't suffer large losses in their pension funds. "Boards are concerned about not making headlines," said Paul S. Maregini, a senior vice president and director of marketing at Mellon Trust.
Some executives of large pension funds asked Mellon to develop electronic agents. They wanted the agents to trip an alarm if a manager significantly exceeded any of the fund's guidelines, Mr. Maregini said.
Mellon's Investment Monitor is part of its client information delivery product, Workbench for Windows. Investment Monitor is in its final testing phase.
Other trust/custody bank executives reported similar requests from clients. They noted pension executives don't have the time to leaf through thick transaction reports looking for problems.
The agent mechanism can be triggered to run tests at intervals. Trust and custody clients at Northern Trust and State Street Bank can get messages about policy violations through their e-mail. That helps if the client isn't, at the moment, hooked up to the custodian's communication system.
Mellon will add that e-mail feature to its program in its next release.
Cost may be negotiable
Cost figures aren't readily available, but Mr. Maregini says Mellon is thinking about charging $20,000 to $25,000 a year. But with the bidding so fierce for trust and custody contracts, deals probably will be made. Besides, any additional cost might seem high, unless it saves your job, custodial bank executives say.
So far, Northern Trust has about a dozen clients for Alert, expects about 50 in the not too distant future, and thinks the number of users could rise to about 300. Mellon's product has four users. State Street bank has "a handful of users," Mr. Darr said.
Not all of the products may be the same. Mellon's Mr. Maregini said although not all bank systems integrate their domestic and global systems, Mellon does. Through integration, he says, clients are more likely to be alerted if a violation occurs when a global portfolio in the aggregate is scrutinized. State Street Bank's systems also are integrated, Mr. Darr said.
One surprise so far, Northern Trust's Ms. Spain said, is more plan sponsors than expected are asking for help in developing their investment guidelines. Ms. Spain said Northern Trust executives thought most plan sponsors would have already identified their guidelines.
Capital Management Science's product is different in that it isn't connected to a custody bank operation. Its BondEdge compliance module tracks fixed-income investments and identifies changes in bond portfolios that violate policies set up by internal management.
Strong interest in the module has been shown by pension funds as well as investment consultants and mutual fund companies, according to Lauri Adami, a managing director.
"Fixed-income securities have become more complex with the potential for greater risk," she said. More than 70% of Capital Management's clients stressed the need for the module in a recent survey, she said.