Print Edition
September 2010 
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Risk Management For Investment Funds |
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Claire Spencer, March 2010 |
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Page 2 of 2 |
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Practical measures
If fund managers are not committed to creating and implementing a risk management program, they will be at a disadvantage in their market. They need to foster an environment in which concerns about risk can be expressed, logged and tackled in a systemic manner. Such programmes need to be integrated into an existing organisation, and should be a key part of portfolio management. Of course, risk management is not an isolated organisational process; there is a need for complementary regulation, for external controls and checks to help stabilise the market. Nonetheless, risks can be considered in two broad groups: investment risks – such as those associated with volatility, leverage, concentration, style drift, liquidity, geographical, geopolitical, currency and valuation – and operational risks – such as those associated with conflicts of interest, counterparty, fraud and business model. Investment risk has been the main concern and this is likely to continue, notes Mr Niggli.
“Aside from this, funds should particularly focus on certain high-risk areas. For example, regulated funds have essentially ignored credit risks arising from their counterparties. This has dramatically changed with the collapse of Bear Stearns and Lehman Brothers, and the need for governmental support by a substantial number of system-relevant banks. The old saying that one does not have really to care about counterparty risk with respect to the brand name international banks, since the end of one bank would be the end of the system, has proved to be wrong,” he says. Now, counterparty risks arising from sub-custody arrangements, securities lending arrangements, cash deposits etc., are finally a focus.
Liquidity risk has also largely been ignored by regulated funds. The drain of liquidity away from hedge funds and the resulting difficulties faced by fund of hedge funds have demonstrated this fact. Homogeneity of the investment base is a particularly big problem, as simultaneous redemptions are more likely in these circumstances. In such cases, funds need to implement mechanisms such as holding technical liquidity, increasing credit lines and establishing notice periods to protect investors from losses. Whether this will become common practice remains to be seen. Although fund managers are not openly disputing the benefits of effective risk management, this does not necessarily equate to actual implementation. “There are generally small or start-up managers that are not prepared to implement a comprehensive and effective program. As alternative investments become more and more institutionalised, and particularly if they become more highly regulated, the practical barriers to entry increase. Anyone trying to launch a fund without adequate capitalisation should understand that a fund will not be able to attract quality investors and, worse still, the firm will expose itself to potentially devastating liabilities by skimping on oversight. Fortunately, if a firm is committed to effective risk management but merely lacks the internal staff, there are excellent service providers in the field available to help,” notes Ms DeFalco. Some fund managers can be reticent to disclose their risk management frameworks to potential investors, partly due to the integration of the risk framework into the general risk management process, which is generally kept under wraps – although others are the opposite, keen to show off the robustness of their risk management.
Nonetheless, as the alternative investment industry becomes more institutionalised, the focus on risk management will become even more intense. Investors are continuing to conduct more due diligence on fund managers, and further, are demanding far more transparency. Ultimately, higher and more consistent standards of risk management have the potential to be a good thing for the industry. A portion of those funds that choose not to adapt are likely to succumb to one or more of the myriad risks they face, while those that remain increase their vigilance and create a stronger industry in the long term.
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