Our last two blogs on structured credit covered in detail the ever-evolving complexities involved in pricing structured instruments, especially during the pandemic. Luckily, these complexities can be managed with the introduction of automation to improve efficiency and transparency throughout the pricing process, thus leading to the generation of alpha. There are several areas within the pricing process that can be streamlined and automated as indicated below:
COVID-19 has drastically changed the world and its economy in unprecedented ways. With a specific focus on the financial industry, the pandemic has caused securitized credit instruments to face a much higher risk of credit downgrade and default. This risk is due to the decreased ability of the counterparty to honor payment obligations and to make matters worse given the current situation, lower valuations and changing credit ratings pose an additional challenge in the pricing process. Throughout this blog, we will explore a few aspects involved in the process of pricing structured credit instruments to help you navigate these uncertain times.
Pricing and valuation is an inherently complex process. Funds are pricing hundreds, sometimes thousands, of instruments in dozens of portfolios, using inputs from multiple market data vendors and broker quotes. These are typically categorized as listed, over-the-counter (OTC) and private securities. Since most funds have a relatively small team devoted to the task of calculating both daily and monthly prices, they have developed over time highly customized spreadsheets for each category of securities to make the process easier.
Due the fact that hedge funds deal in both liquid or illiquid assets, a number of added nuances and complexities tend to have an impact on the pricing process. Prices of liquid instruments are readily available and less disputable, which is why those that deal in liquid instruments, such as long-short, global macro and activist funds, have a more straightforward pricing process. For funds that deal in illiquid assets, such as swaps, ABS, MBS, bank debt, loans and private deals, the pricing process is a much more involved exercise for each of the following reasons: Read More