Open Protocol: Comparing Apples to Apples

Evaluating the risks of a large cap value portfolio against those of another has long been a relatively easy exercise for investors. However, evaluating the risks of an absolute return-oriented risk premia fund versus those of a relative value multi-strategy hedge fund is not, even though they can have the same stated investment objective.Investors who embark on this noble endeavor often find themselves subjectively interpreting proprietary risk reports, potentially leading to headaches resulting from both accuracy and accountability issues.

(Estimated reading time: 2 min, 36 sec)

Without a common risk language for defining exposures across multiple asset classes, long and short, the process of monitoring portfolios of liquid alternatives has been like the failed Biblical attempt to build the Tower of Babel. Not scalable. Not stable. Not easily replicated. In other words, not practical. Until now.

In a recent announcement, the Hedge Fund Standards Board (HSFB) just recognized an industry-backed initiative called Open Protocol. As a freely available, standardized template now within HFSB’s Toolbox, Open Protocol helps hedge fund investors with matters of fund governance, if not risk management. While proprietary risk reports from managers can be useful for additional insights, Open Protocol provides common reference points of systematic risk exposures across asset classes, geographies, industry sectors, credit ratings, liquidity spectrum, and other common risk factors.

Callan believes that this template will enable investors to better understand their risks within an investment strategy using leverage, illiquidity, and shorts and across a broad portfolio of such complex strategies. Given this improved understanding based upon standardized risk exposures, investors can “own” the underlying risks while monitoring them over the ebbs and flows of market cycles. This risk reporting tool can also be the basis for aggregating risk exposures across most, if not all, fund sponsor allocations, so its application is not limited to hedge fund and liquid alternative implementations.

Demonstrating its commitment to this standardized risk reporting format, Callan recently joined the Working Group overseeing the Open Protocol template, along with other organizations including: Albourne Partners (as co-Chair with HFSB), Brevan Howard, BT Pension Scheme, CITCO, Credit Suisse, D. E. Shaw, Aptitude Investment Management (fka Federal Way), Goldman Sachs, International Fund Services, Investcorp, Lansdowne, Morgan Stanley, Och-Ziff, Thomson Reuters, UBS, and Utah Retirement Systems.

According to the HFSB announcement, Open Protocol currently is used by managers representing over $1 trillion of fund assets, signifying a growing rate of industry acceptance since its 2011 launch. Beyond wanting to help their investors understand complex risk data, why should managers seek to produce risk reports in the Open Protocol format? In a word: efficiency.

Currently, these managers often have to deal with time-consuming investor requests to complete their own customized risk templates that typically have very similar data fields as Open Protocol. One key benefit of this HFSB-recognized template is that a manager will be able to consolidate its risk reporting deliverables into one template based on Open Protocol along with, or in lieu of, the manager’s own proprietary risk report. All parties are likely to benefit as the hedge fund community moves from a “tower of Babel” to a lingua franca in terms of risk reporting and fund governance.