Hail to the Chief - Risk Officer That Is
In "Risk Redux" by Kristin Fox, founder of Fox Inspires, LLC (Private Wealth, January 7, 2010), I am quoted extensively on the topic of risk management. I'm happy to note that others interviewed for the article reiterate many of the points I made.
Given the changed landscape, post Madoff and so on, the life of a Chief Risk Officer ("CRO") is even more harried than ever before. He or she is often expected to save the ship without impeding the traders' ability to turn a profit. Applied to hedge funds, the task is arduous indeed as the threat of global regulation looms closer and investors clamor for heightened transparency about fees, concentration of positions and overall risk-taking.
Since so many pensions, endowments and foundations are adding to their hedge fund allocations, the article is worth a read. Some of my talking points are listed below:
- Risk management is an integral part of a firm’s culture and one of the keys to its success. “Instead of looking at risk management as a roadblock, it should be promoted as part of your culture and viewed as the best way to ensure the firm’s longevity.”
- There is no one size fits all approach to hedge fund risk management. It depends on the size of the organization, strategy, type of clients, risk tolerance, to name a few items.
- A CRO must ask tough questions about the risk "cost" of every expected dollar in return.
- Compensation must support the notion of a risk culture or any other efforts to mitigate risk are doomed to fail.
- Kick the tires on models. Ask if underlying assumptions prevail.
- Make sure that everyone understands the nature of leverage, from the back office clerk to the front room trader.
- Acknowledge that risks seldom live in isolation. One of the unpleasant surprises of 2008 and 2009 had to do with the convergence of risks. The traditional reliance on correlations had no place in the volatility maelstrom that created heartburn for a lot of investment professionals. "For example, with structured products, liquidity risk was arguably greater than anticipated because the quality and quantity of supporting collateral was sometimes wanting. For any financial institution that had hedged part of its structured product portfolio, it may have found itself with another risk in the form of counterparty defaults. The risks are often not additive, and a good CRO needs to truly understand the interrelationships among financial, operational and legal risks, to name a few."
- Figure out a way to overcome the resistance of those who are already burdened with their own work but who are nonetheless critical to the risk management process. A good CRO must make friends and motivate accounting, legal, systems and trading to hold hands and come together to properly manage the R word.
Though written in 2003, my article entitled "Life in Financial Risk Management: Shrinking Violets Need Not Apply" is still relevant. I describe the building block concepts as well as the skill set required for an effective CRO.
