Risk Management with Investors in Mind

by Shyam Prakash

With all eyes on what to expect in 2014, if you ask fund managers what they consider to be the biggest tail risk to markets these days, most would probably answer China. Ironically, the risks posed by global factors such as China can seem easier to understand for investors than the risks in their own portfolios. How well investors actually understand risk is a critical issue that hasn’t been addressed as fully as it probably should be. It was one of the questions that came up at this year’s annual Gravitas Trends 2014 event in New York this past October.

Co-moderating a roundtable called “Rethinking Enterprise Risk” with Jon Kinderlerer, managing director and head of risk advisory for credit prime services at Credit Suisse, we heard numerous participants ask important questions about risk, notably: Where does the risk really reside and who’s really managing it? It is a major question that we address with nearly every Risk Co-sourcing engagement.

Among the many lessons about risk that came out of the financial crisis, knowing where it actually exists is key. This has become especially challenging since the risk spectrum has become more complex than ever, spanning portfolio, market, liquidity, as well as operational risk. The difference between market liquidity and structural liquidity became painfully apparent when some investors found themselves unable to exit gated funds or unwind otherwise relatively liquid positions owing to restrictions lurking in the fine print of offering documents.

Directly related to where risk resides is the matter of who actually has control over it. Is it traders, the CRO, the CIO? Many feel the buck stops with the CIO, but that the role of the CIO has changed dramatically since the financial crisis of 2008.

The central role of investors in the risk equation is part of the larger matter of how investors and hedge funds alike should approach the process of assessing risk systems. Among the fundamental points that need to be addressed in this regard are:

• How well integrated is the risk system in the larger operational picture?
• How effectively does a risk system accommodate the multiple needs of diverse investors? For example, selling the importance of a data-intensive risk system to an investor with a non-data-centric orientation can be a significant challenge.
• Directly related, how easily can output from a risk system be transmitted to investors in terms they can readily understand and use?

Added to the above are other, emerging imperatives of risk reporting (such as real-time reporting), all of which revolve more than ever around data. Managing the data deluge – for purposes of risk and otherwise — has become a defining requirement for hedge fund operations professionals.

Keeping investors in sharp focus while contending with these and other challenges will be a top priority for 2014.