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Still scared

Specter of 2008 still drives institutional investors to focus on risk, study finds

Harry Markowitz

Risk is dominating the investment conversation among institutional investors, and the financial crisis of 2008 still remains the main reason almost six years later, according to a study released Tuesday by Bank of New York Mellon (BK) Corp. (BK) in collaboration with Harry Markowitz, 1990 recipient of the Nobel Memorial Prize in economics.

Sixty-eight percent of the 88 pension funds, endowments, foundations and other institutional investors that responded to a survey for the study, “New Frontiers of Risk: Revisiting the 360-Degree Manager,” said the financial crisis was the biggest motivator to focus on risk. Increased awareness and knowledge of risk also scored high as a driver, indicated by 63% of respondents.

“2008 was not an outlier,” Mr. Markowitz said in an interview from his San Diego office. “It's not even the worst year ever. The crisis made investors understand what a standard deviation is. It was a wake-up call for something they should have learned already.”

Among the broad themes of the study: More emphasis by institutional investors on achieving absolute-return targets vs. outperforming a market benchmark; the expansion of alternatives allocations; the continued use of risk-return analysis and performance attribution to gauge their investments; and increased transparency on investments, including exposure to leverage.

“How do you get transparent? How do you understand counterparty risk? This is the new landscape, to be able to extrapolate other kinds of risk,” said Debra Baker, managing director and head of BNY Mellon's global risk solutions group, New York.

Among the other findings: 80% expect risk to play a greater role in future investment decisions; 73% expect to spend more time on investment risk issues; 68% expect to spend time on operational risk issues; and only 25% had a chief risk officer. However, less than 30% of respondents plan to spend more time on issues related to political risk.

Mr. Markowitz, who first introduced modern portfolio theory in 1952, said he was heartened by how many respondents “still used MPT for real.” In a BNY Mellon report in 2005, about 80% of institutional investors used MPT for asset allocation and attribution analysis, “and in 2013, it's still about 70% to 80%,” he said.

Mr. Markowitz said one takeaway from the latest report is that instituitional investors need to continue integrating risk control at the enterprise level, rather than at the individual portfolio level. “They should spend more time on two levels: hire managers that interact on a plan level, and take into account all of the impacts of risk models.

The full report is available on BNY Mellon's website.