BNY MELLON
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An Inside Look into Institutional
Investment Risk Management
The growing importance of risk management for
institutional investors remains a key conversation in
financial markets around the world. Not differently in
Latin America, with more regulated markets than ever,
where companies follow high standards of industry
practices, properly assessing risk is actually one of
the biggest risks faced by investors, and needs to be
supported by deep knowledge of the market and
strong quantitative techniques.
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 program.
Using some form of quantitative scoring across major risk
categories may be the next frontier of risk management.”
In a study entitled New Frontiers of Risk: Revisiting
the 360° Manager1, published by BNY Mellon in collaboration
with Nobel Prize-winning economist Dr. Harry Markowitz,
over 100 institutional investors from different parts of
the world were surveyed, including pension funds and
endowment & foundations, with approximately $1 trillion
in aggregate assets under management.
According to Adriano Koelle, Chairman for Latin America
and Country Executive for Brazil at BNY Mellon, “the global
financial system is basically a machine to allocate capital.
When they fail to measure risk and thus fail to allocate
capital efficiently, the whole industry suffers as we could
see in the recent crisis in 2008”.
Among the many interesting findings revealed, we see that
over 80% of institutional investors expect risk management
to play an even greater role in the investment decision
process in the future. In addition, over the next five years
73% expect to spend more time on investment risk issues,
while 68% expect to spend more time on operational risk
issues. Only 25% 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,” says Debra Baker,
Yet on the crisis theme, Dr. Markowitz notes: “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.”
Our Key Findings
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No more chasing alpha: it is down with alpha and up
with targeted returns. 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.
Increased use of alternatives: survey respondents
have expanded their use of alternative investments
to improve diversification and potentially help with
downside risk. Institutional investors plan to increase
their allocations to alternatives over the next five years.
A re-awakening of risk awareness: the 2008 financial
crises caught many institutional investors off guard.
The risk management procedures then in place were
widely perceived to be insufficient for a crisis of such
Risk management has become a key priority of almost all
investors. When discussing market risk from a regional
perspective, for instance, “in emerging markets, the risk
is not the same when you consider country specifics.
Investors have been scrutinizing more, and countries with
stronger basis, when considering their monetary policies,
demographics, regulatory environment, etc., are perceived
differently. In Latin America, this is very true when we
think of the rich and diverse reality of countries’ different
momentums and specifics”, adds Koelle.
There is no doubt that risk management has grown
substantially in importance. Although managing
investment risk continues to be paramount, a whole
spectrum of other risks (political, legal, operational,
etc.) has become a centrally important component of
institutional investors’ risk management responsibilities.
When seeking to strengthen risk management practices,
the most general take-away from the survey tells
institutional investors to develop a holistic view of risk,
evaluating investment, operational and other types of
risks to support top-down strategic decision making.
Also, ensure the risk management function has sufficient
resources to implement, monitor and communicate
relevant risk measures.
We are at the point where there is an undoubted
acceptance that risk includes many components. Still,
what seems to be missing is a collective risk management
framework that incorporates each of these areas of risks,
considering not only the individual contribution of each,
but also the impact they have on each other and the
overall investment program.
“We see this happening with our Latin American clients
where the diversification into different asset classes
and global investments drive the need for comprehensive
magnitude. The drive for more effective, holistic risk
management was soon on.
Analytical tools on the front lines of risk management:
analytical tools based upon risk-return analysis
and performance attribution continue to be the
most commonly used to model, analyze and monitor
investments. Total plan/enterprise risk reporting tools
are on the rise to encompass traditional and alternative
investments, as well as liabilities.
Avoidance of unintended bets: a desire to avoid
unintended leverage and to better understand
underlying investments has grown markedly since
the 2008 financial crisis and appears to be driving
institutional investors toward solutions offering greater
investment transparency.
risk management for their complex portfolios”, states
Carlos Augusto Salamonde, BNY Mellon’s Head of
Asset Servicing for Latin America.
There is a unique opportunity for academics and the
industry to review the interaction of these many other
risks alongside market risk, and consider whether it makes
sense as part of the next phase of developing effective
risk management practices, for a new, broader risk model
to emerge, which would help pave the way for the next
generation of risk systems, models and debate.
BNY Mellon can help. We are a global investments
company dedicated to helping clients manage and service
their financial assets throughout the investment lifecycle.
By combining comprehensive investment risk services
that help you monitor risk across your investment process
with integrated performance solutions, we can help you
compare, evaluate and understand the impact of your
investment decisions. And by being committed to the
Latin American market, we can serve you locally.
Contact us at [email protected].
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The full report is available online at: http://www.bnymellon.com/foresight/risk/
frontiers-of-risk-baker-markowitz.html
The material contained here, which may be considered advertising, is for general
information and reference purposes only and not intended to provide legal, tax,
accounting, investment, financial or other professional advice on any matter, and is
not to be used as such.