Sit Down, Risk Managers

Terry Flanagan

Today’s top market theme is risk management, but current ways of safeguarding investments may be hindering, not helping, firms, according to buy-side manager.

Institutional investors were especially hard-hit in 2008 as the global credit crisis stripped away a large portion of portfolio liquidity. The endowment, foundation and pension, community has been riding the pendulum of risk versus return, and it seems as though risk remains paramount as global volatility is predicted to continue in 2012.

Hedge fund investors, too, are concerned with risk. Ensuing global market volatility also remains their top concern, followed by personnel, leverage, fraud, and accounting risk, according to research provider, Eurekahedge. Buy-side firms have answered investors’ questions about their risk appetite by showcasing their risk versus return profile through implementing various software, technology, and tools.

But when does more systems equate to too much?

“When market crashes occur, such as the 1970s stock market crash or more recently, the Flash Crash, everyone’s idea is to add more ‘safety’ features, but in reality that makes systems much more complex,” said Aaron Brown, risk manager at well-known quant hedge fund, AQR Capital Management, and author of Red-Blooded Risk: The Secret History of Wall Street.

“Risk managers should subtract, not add,” Brown told Markets Media, noting that many firms’ risk management systems provide more-than-sufficient capabilities, yet go wrong because business units don’t properly communicate with their risk managers—a lack of “rich interaction.”

As trading technology becomes increasingly more electronic and advanced, firms get into trouble because “one person takes crazy risks for a small profit,” and “others are extra cautious and turn down opportunities because of risks,” noted Brown.

According to him, firms today wrongly assume that poor decisions are at the fault of their risk systems alone, when the culprit is often the miscommunication of opportunities and risks between investment managers and risk managers.

“People in the business unit do not see what’s happening with the entire firm because they’re worried about shareholders, rating agencies, banks, regulators, and equity analysts,” said Brown.

Sybase Financial Services, a solutions provider that hosted a capital markets forum with Brown, specializes in database and trading technology that focuses on connecting this gap of knowledge within firms. The firm’s systems harbor tools to enhance “situation detection,” and an “automated response,” according to Sybase Director of Marketing, Neil McGovern.

“With today’s high speed trading, data engines are often coming into too fast for many buy-side firms,” he said. “But no matter how fast data is coming in, we can provide a buffer for that velocity for our clients.

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