The plunge in the price of transmitting electronic data is giving money managers the ability to change investment portfolios even as securities markets are moving.
According to investment consultants, the ability to make portfolio changes wasn't possible before because of high costs for transmission of the data necessary to monitor a portfolio.
Being able to make small insightful changes in a portfolio could help managers lessen adverse impacts or magnify positive effects to portfolios. Many managers would have wanted that ability recently when they learned only too late about the effects of rapid interest rate rises on their portfolios.
"This (virtual reality) is the next technology in our business. It will change our industry completely," said James Kaplan, president of Capital Management Sciences, Los Angeles, an investment consulting and analytical software firm whose products in the fixed-income area are used by hundreds of portfolio managers.
Mr. Kaplan, a former portfolio manager himself, said the price of data transmission is one-tenth of the old cost in part because of the use of the Internet.
The decline will allow some portfolio managers to immediately "see new information, process it and make a decision," said Kamal Duggirala, president of BARRA Inc., Berkeley, Calif., a leading investment consulting and software analytical firm that operates in 30 countries and has more than 800 clients.
Mr. Duggirala has an MBA in finance from the University of California at Berkeley, and has done empirical research in option pricing theory with Mark Rubinstein, founder of Leland O'Brien and Rubinstein. BARRA acquired software technology from LOR last year.
Mr. Duggirala was responsible for developing the POSIT system, which was the first electronic market for trading equity portfolios.
"For the new generation of portfolio managers, it is certainly a different game than it was before," said Mr. Duggirala.
Until recently, the price of transmitting data - such as constant streams of the real-time prices of securities - was too expensive for most managers. The cost collapsed with increased use of the Internet and satellite communication.
"You can clearly see that telephone companies are investing huge amounts of money in fiber-optic cables," he said. The capacity of those cables to transmit data will be enormous, he said, and telephone companies will be selling their excess capacity to transmit data.
But receiving the data is no help unless those money managers can manipulate and analyze it quickly.
Some portfolio managers can manipulate and analyze data and its effect on their portfolio at high speed by using one of the programs from CMS; BARRA; Vestek, San Francisco; Wilshire Associates, Santa Monica, Calif.; Ibbotson Associates, Chicago, Global Advanced Technology Corp., New York; or other high-tech firms.
Despite the sharply increasing amount of data and increasingly gigantic portfolios, some managers still are slow to take advantage of technology.
Mr. Duggirala predicts that use of analytical models will become a necessity. "If you have a million numbers in a day (transmitted) to you, you might want to use only 20 numbers that tell you what you need to do; that is the kind of reduction that you need to intelligently deal with that kind of a flow of information," he said.
The ability to digest data and make midcourse corrections in investment portfolios is still revolutionary and evolutionary. In the past, the best that even the most technologically sophisticated money managers have been able to is to play what-if games or run scenarios on the value of their investments given certain conditions.
That ability to run scenarios and show how portfolios might be affected has been a boon to money management. It has helped managers understand what risks they were taking. The key risk has always been how they would perform relative to the benchmark that pension funds have told them to beat.
Falling too far below a benchmark can lead to loss of business from a pension fund and loss of huge investment fees.
But as good as the system of running scenarios has been, it is far from perfect.
The scenarios were run well in advance of market changes caused by such things as a slight increase in interest rates. As a result, managers sometimes were wrong about what they thought would happen.
"The problem is that in the real world we didn't put in the scenario that actually occurs,"
said Mr. Kaplan.
The distinction Mr. Kaplan is making is an important one. Managers are formulating scenarios of what could really happen. While the scenarios can be helpful, the scenarios are never exactly on target because they are guesses about the market. The complex securities market world always behaves differently than anyone expects.
The new virtual world that can be seen with rapid data transmission and software analysis is the closest thing yet to the actual world of securities.
The virtual world can't show the real world yet partly because some securities don't trade often enough to exhibit immediate pricing changes. However, the virtual world is close enough, the experts say, to make small but informed changes in a portfolio.
When the real-world markets move they are "going to look a little bit like the scenarios we tested, but we haven't tested the real-world scenario," Mr. Kaplan said.
"In the real world, some things are going to wiggle and woggle in ways we didn't expect. We won't know that unless we see it," said Mr. Kaplan.
But managers who are getting the data and have the analytical models to massage it are going to be seeing a virtual real world.
Mr. Kaplan added, however, that the ability to see a virtual real world is a tool, and it is up to the money manager how well he uses that tool.
The falling cost of transmitting data is going to have other important implications as well, said Mr. Duggirala. He said he has seen a dramatic increase in investing around the world.
Mr. Duggirala said he is surprised by the wide use of the Internet even in Asia. But, he said, using it for low-cost transmission of data "is only the beginning in my view."
Because of the availability of data, managers are going to feel more comfortable about investing globally. As global investing becomes more popular, "I think you are going to see a tremendous shift in the capital flows" and "greater emphasis" by U.S. investors investing outside the United States.
Mr. Duggirala also predicts that the ability of investors to make decisions will create pressure to automate trading systems.
He said some countries of Europe, like Switzerland, have highly automated trading systems because officials of those countries have been able to build their systems from scratch, instead of being forced to upgrade current systems.
