Institutional investors see wood for the trees
18 February 2014 New York
Image: Shutterstock
Institutional investors expect risk management to play an even greater role in the investment decision process in the future, according to a new study by BNY Mellon and Nobel Prize-winning economist Dr. Harry Markowitz.
Over the next five years, 73 percent of institutional investors expect to spend more time on investment risk issues, while 68 percent expect to spend more time on operational risk issues. Only 25 percent of respondents, however, had a chief risk officer.
“Institutional investors are up against some formidable risk pressures, from new regulations to transparency concerns to investment risks across the board,” said Debra Baker, head of BNY Mellon’s global risk solutions group.
“For many, risk management has been a puzzling proposition – just when they think most risks have been measured, managed and mitigated, new ones emerge and old ones evolve. We see the need for a collective risk management framework that incorporates all areas of risks, their impact on each other, and one’s overall investment programme. Using some form of quantitative scoring across major risk categories may be the next frontier of risk management.”
The new study arrives almost a decade on from the publication of BNY Mellon’s 2005 white paper New Frontiers of Risk: The 360O Risk Manager for Pensions & Nonprofits, which also included input from Dr. Markowitz. The 2005 paper highlighted how the need for more structured and holistic risk management was just beginning to be recognised.
Dr. Markowitz said: “The crisis of 2008 was different. So was the crisis that started in March of 2000 with the bursting of the tech bubble. So will be the next crisis. The moral is that one will never be able to put the portfolio selection process on automatic."
"The trusted quant team needs to constantly evaluate the current situation. It should also make sure that higher management understands what assumptions are being made, how and by whom any exotic asset classes being used have been evaluated, and what the vulnerabilities are of the general approach that is being taken. Furthermore, the push to integrate risk-control at the enterprise level, rather than at the individual portfolio level, should be continued.”
Key findings of the new study, which surveyed more than 100 institutional investors, including pension funds and endowments & foundations, with approximately $1 trillion in aggregate assets under management, include no more chasing alpha, whereby institutional investors are placing greater emphasis on achieving absolute return targets as opposed to outperforming a market benchmark. Risk budgets, matching liabilities and avoiding downside risk all play an important role in this shift.
There has also been a drive towards analytical tools based upon risk-return analysis and performance attribution continue to be the most commonly used to model, analyse and monitor investments.
Total plan/enterprise risk reporting tools are on the rise to encompass traditional and alternative investments, as well as liabilities.
Finally, the study showed a desire from investors to avoid unintended leverage, and to better understand underlying investments.
Over the next five years, 73 percent of institutional investors expect to spend more time on investment risk issues, while 68 percent expect to spend more time on operational risk issues. Only 25 percent of respondents, however, had a chief risk officer.
“Institutional investors are up against some formidable risk pressures, from new regulations to transparency concerns to investment risks across the board,” said Debra Baker, head of BNY Mellon’s global risk solutions group.
“For many, risk management has been a puzzling proposition – just when they think most risks have been measured, managed and mitigated, new ones emerge and old ones evolve. We see the need for a collective risk management framework that incorporates all areas of risks, their impact on each other, and one’s overall investment programme. Using some form of quantitative scoring across major risk categories may be the next frontier of risk management.”
The new study arrives almost a decade on from the publication of BNY Mellon’s 2005 white paper New Frontiers of Risk: The 360O Risk Manager for Pensions & Nonprofits, which also included input from Dr. Markowitz. The 2005 paper highlighted how the need for more structured and holistic risk management was just beginning to be recognised.
Dr. Markowitz said: “The crisis of 2008 was different. So was the crisis that started in March of 2000 with the bursting of the tech bubble. So will be the next crisis. The moral is that one will never be able to put the portfolio selection process on automatic."
"The trusted quant team needs to constantly evaluate the current situation. It should also make sure that higher management understands what assumptions are being made, how and by whom any exotic asset classes being used have been evaluated, and what the vulnerabilities are of the general approach that is being taken. Furthermore, the push to integrate risk-control at the enterprise level, rather than at the individual portfolio level, should be continued.”
Key findings of the new study, which surveyed more than 100 institutional investors, including pension funds and endowments & foundations, with approximately $1 trillion in aggregate assets under management, include no more chasing alpha, whereby institutional investors are placing greater emphasis on achieving absolute return targets as opposed to outperforming a market benchmark. Risk budgets, matching liabilities and avoiding downside risk all play an important role in this shift.
There has also been a drive towards analytical tools based upon risk-return analysis and performance attribution continue to be the most commonly used to model, analyse and monitor investments.
Total plan/enterprise risk reporting tools are on the rise to encompass traditional and alternative investments, as well as liabilities.
Finally, the study showed a desire from investors to avoid unintended leverage, and to better understand underlying investments.
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