From the trunk to the driving seat, but avoiding crashing?
Risk management and compliance have both been
part of big investment bank’s and financial firms operations for decades.
However regulatory bodies have posed much stricter regulations and requirements
on bigger companies in general and financial institutions in special after
2007-2008. Control level and focus increased first after the Enron, WorldCom
and Parmelat cases 10-15y ago, then increased again after 2007-2008. Risk
management functions in banks or corporations having to handle both liabilities
and assets and in general a vast number of derivatives, also complex ones is
more demanding than for a pure asset manager. Estimating sufficient capital for
future operations is a significant task taking months involving many people in
large institutions. For pure asset managers investing other peoples money, it
is the investors risk, not directly the company’s risk. Some risk might be
mitigated through guarantiy clauses from the management company that for
example all costs due to operational errors shall not be covered by the
clients, but by the management company.
Fitting the risk management to an appropriate
size and level of interference in any company is a key task. Too much is too
costly, too little might be even costlier..
Included in what is to be considered in
this process should besides only data warehouse items and quantitative
calculations also be commercial aspects, what’s popular and not and in
what markets, what is on PMs, senior managements, and the Board of Directors’
agenda. Also clients feedbacks should to some extent be taken into account
when tailoring how to measure, analyse, manage and present the risk
picture.
For example key trends to analyze could for private/retail clients incl. high net worth be
₋ whether they prefer absolute or relative mandates
₋ what would be the right amount of contact with them – is it
"less is more" or is "less 'less' ". Less is anyway
arguably cheaper.
₋ is
your company perceived a stock investor, a bond/fixed income
manager, generally a savings bank, or a combination. For example if you're
perceived a fixed income manager, your FI funds would typically sell better
than your equity funds for an equal risk adjusted performance.
For institutional clients incl. high net worth, key issues could be
₋ separating
alpha and beta strategies,
- whether you should offer overlapping
mandates
₋ how theoretically thorough or focused your clients are. FLAM (fundamental law
of active management) outset seems out after the last financial crisis –
correlations help you when you don’t need it … and vice versa! But do always
assume your client is clever and professional and treat them thereafter.
₋ Bigger
clients more and more tend to use consultants and pick funds from several vendors.
They act increasingly professional but past performance still an important
driver
In between investment analyst and a compliance officer:
Traditionally an old school mid office worker had low authority and low
importance/impact on investment decisions. A business or investment / risk
analyst sitting next to portfolio managers supporting on the desk on a daily
basis has low authority but a higher impact on investment decisions (at least
if she/he is good). A compliance officer on the other hand has low impact on
investment decisions however a high authority in the organization since they
deal with laws and external regulations which may lead to fines or penalties
from regulatory authorities if breached.
A risk manager however was traditionally close to an old school mid/back
office analyst, but had gradually moved towards both higher authority and an
induced higher impact on investment decisions if his/her role is communicated
correctly and the internal risk culture of the company is right.
The below picture shows the principle. In my opinion the risk managers role
especially after 2007-2008 is a move towards the upper right quadrant from the
lower left quadrant.
You should in general find the right level of risk control, measurement and
management – better is more expensive and may not outweigh the cost, size of
the organization nor type of your businesses. See picture below.
The CEO is the CRO:
And remember, despite having afforded the costs of the top level above –
risk management - a lack of risk culture and over reliance on models and
complexities based on assumptions that might brake spins a vulnerable safety
net. Small flies are may be caught, but you must make sure the big bugs don’t
fly straight through it. You strengthen the net by insisting on a decentralized
risk culture where “basically everybody” are risk owners, and the CEO is the
CRO. If the former cannot answer what the biggest risks facing her/his company
in a short time without having to consult the risk people or others, the person
should go. Risk is a top management issue, not a back-, mid-, front- or
compliance group issue only.
The information,
views, and opinions expressed in this blog are solely those of the author in
person and do not reflect the views and opinions of SKAGEN Funds.
Happy
Easter.
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