Institutional investors are expected to continue to struggle with risk management in the coming year, trying to achieve a proper balance between achieving control of their risk and the costs of gaining that control.
Even though some large pension funds and money managers have taken the lead, many institutional investors still are wondering how closely they should follow.
For plan sponsors, many of the risks they face dwell with the outside managers they hire, making risk management even more difficult.
And while the number of investment blow-ups might have slowed in 1996, some industry experts say that it is when things are most quiet, and markets are robust, that risk management becomes even more important.
From a regulatory standpoint, a pending U.S. Supreme Court decision involving the Commodity Futures Trading Commission is likely to clear the waters regarding derivatives risk management.
And, the recently released set of guidelines for plan sponsors and money managers produced by the Risk Standards Working Group could make it easier for smaller institutional investors to assess where their risks are and how to manage them.
Christopher J. Campisano, manager-trust investments for Xerox Corp., Stamford, Conn., and a member of the risk standards group, said risk management continues to be a major focus.
"I think the whole issue of risk management in of itself is the latest trend," Mr. Campisano said.
But he said the focus has begun to shift from the traditional view of risk - which generally uses quantitative techniques to examine the capital markets - to a broader view of risk, using qualitative gauges.
"The idea of really understanding the qualitative side of risk and oversight is important," Mr. Campisano said.
"You need to have proper checks and balances and proper oversight," he said.
Michael deMarco, director of risk management for GTE Investment Management Corp., Stamford, Conn., said putting risk controls in place is likely to cost more than people expect. (Mr. deMarco is also a part of the risk standards group).
As investors move further along in the process of developing a risk management process, unexpectedly high costs are likely to cause some to go slower than maybe they should, he said.
"It's particularly daunting for smaller organizations to implement a real, independent, risk management process," Mr. deMarco said.
Getting outside investment managers to buy in to the process also is likely to be an impediment, he said. Any additional risk management that managers have to do for clients takes money from their bottom line.
And for some investment shops that consider themselves, say stock pickers, risk management isn't a priority.
William Miller, senior vice president and independent risk oversight officer with The Common Fund, Westport, Conn., said he expects to see continued strong interest in risk management.
But he said he's concerned investors might focus too much on trying to achieve a quick resolution to their risk management needs.
Mr. Miller said investors should turn to as many sources as they can in trying to gain an understanding of the risks they are taking.
Roger Bransford, managing director for Watson Wyatt Investment Consulting, Atlanta, said he expects risk awareness to grow quickly among plan sponsors on the portfolio construction side.
There often are unexpected investment risks that plan sponsors take on when they make the leap from asset allocation and asset-liability studies to actual hiring of external investment managers, he said.
On a basic level, there are big risks associated with using passive indexes to construct an asset allocation, but then using active managers to implement it, Mr. Bransford said.
Another big distraction is the booming U.S. stock market.
"When things are percolating in a positive way, risk means something different than when times are tough," Mr. Bransford said.
"It takes a little rockiness, a little volatility," to get people thinking about risk, he said. In 1997, we're likely to see more of this reaction, he added.
That's "a classic cognitive error," Xerox's Mr. Campisano said.
Investment risk is always easier for people to swallow when volatility results in strong returns, he said.
Despite the strong interest in risk management, a rush to put risk management heads in place at pension funds and money managers could be fading.
The rush was part of the fallout from the multitude of big, unexpected investment losses taken at institutions across the globe, such as those seen at Sumitomo Corp., Barings PLC and Orange County, Calif.
Roderick C. Gow, chairman of the Americas region of executive recruiter AMROP International, New York, said those that could afford to hire risk executives already have done so.
But he said the focus on risk management will lead to demand for more experienced investment personnel for all sizes of firms.
Companies are going to look for people that have been through bull and bear markets, which is not a particularly large pool, Mr. Gow said.
In terms of monitoring derivatives risk, the pending Supreme Court case of Commodity Futures Trading Commission vs. Dunn should clear up some of the uncertainty regarding the government's role in derivatives regulation, said Donald L. Horwitz, managing director with derivatives consulting firm The Woodward Group, Northbrook, Ill.
CFTC vs. Dunn involves the question of how much power the CFTC has to regulate the over-the-counter market for currencies.
"Hopefully it (CFTC vs. Dunn) will put some stability into the system" once it's resolved, Mr. Horwitz said.
"People want to know who's regulating them," he said.