Concern about risk management controls among pension plan sponsors is leading them to question how outside investment firms handle risk, industry participants say.
While risk management controls are not new to the money management industry, investment firms have been moved to explain their processes by a slew of unexpected investment losses that worry plan sponsors.
A primary and sometimes under-appreciated component of risk management is the people working within the system, industry experts say.
Pension plan sponsors, who are beefing up their own risk controls, are asking money managers what they are doing to protect clients, said Scott Lummer, managing director in the consulting unit of Ibbotson Associates, Chicago. Sponsors want assurances they're not going to be the next victim, and "they're forcing good answers."
With an increased focus on systems, some industry experts say that how people fit into the picture should not be forgotten.
Gary Brinson, president and chief executive of Brinson Partners, Chicago, said it is very important to have systems and controls but, "When you come down to the bottom line, no system is failsafe. You rely on the integrity of the individual. That's the way the world works."
Mr. Brinson said "peer pressure and peer review is very important" to Brinson Partners' risk management controls. He said it's important for investment firms to limit and control risk effectively, because the existence of a firm can be threatened by incidents like those at Barings PLC and First Capital Strategists.
"That's all we have is our integrity," he said.
Ken Jingozian, partner and chief operating officer for the bank consulting firm Treasury Resources Consulting & Investigating, New York, said that while there is an increasing reliance on systems at financial firms, "the human element is not necessarily making the same kind of progress." He said "an overreliance on systems makes the human interaction more mechanized and less thoughtful."
Executives of Alliance Capital Management Inc., New York, view risk as a combination of process and people, said Kathleen Corbet, president of Alliance Fixed Income Investors, Alliance's fixed-income investment management unit.
Ms. Corbet said Alliance breaks the process down into research, compliance, systems and performance review.
She noted Alliance recently upgraded its risk management systems, hiring an outside firm to provide systems control software.
On the people side, Ms. Corbet said Alliance works to ensure it has qualified people at all levels, plus proper incentives in place. Of course, separation of duties between trading and settlement is also important, she said.
Like Brinson, Pacific Investment Management Co., Newport Beach, Calif., uses a form of peer review to keep tabs on its portfolio managers, said Dean Meiling, managing director. In addition to having systems and analytics, all of PIMCO's portfolios are available for inspection. Portfolio managers "have the ability to look at things and ask questions" about any security the firm owns for its clients, he said.
Mr. Meiling said all of the attention to risk management has led to increased questions from clients on the issue, and for the first time on-site visits from clients or their consultants.
Some investment firms have separate departments devoted solely to risk management.
Richard Davis, managing director of J.P. Morgan Investment Management Inc., New York, said the firm has five people working on risk management for the firm. The group reports separately from its auditors and its compliance and legal departments, he said.
Mr. Davis said the firm's risk management group looks at risk control in four categories:
client issues, such as suitability, disclosure, and the following of investment guidelines;
product issues, such as whether a product is priced appropriately, does it have investment integrity?, can it be priced?;
credit and counterparty risk; and
execution and trading.
HSBC Asset Management, London, recently created a new position to oversee its risk management (Pensions & Investments, Oct. 16). Neil Brown was hired as head of risk management, and is responsible for monitoring market risk, credit risk, and operational risk. Mr. Brown will report directly to the firm's group finance director, Kevin Gregory. Mr. Brown said the idea to create the position pre-dated the collapse of Barings last year.
Howard Mason, vice president and head of asset allocation for BT Global Investment Management, Bankers Trust Co.'s investment management unit, said BT uses risk management techniques developed on the banking side to manage risk in its investment management area.
A key to BT's controls is the identification of factors that pose risk to the firm, and then applying probabilities to outcomes under various market scenarios, Mr. Mason said. In addition to using its risk management system - called Raroc 2020 - internally, it also offers it to plan sponsor clients (P&I, Oct. 16).