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April 14, 1997 01:00 AM

SPECIAL REPORT: RISK MANAGEMENT: MANAGERS, SPONSORS CREEPING ALONG

Paul G. Barr
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    Money managers and pension plan sponsors are making slow progress in a move toward improved risk management that began in the wake of the derivatives disasters of 1993 and 1994.

    And some managers and sponsors who dropped derivatives have tiptoed back, although expectations about how derivatives are used are more defined and closely watched, industry experts say.

    Progress in derivatives risk management has been hampered by a lack of appropriate procedures and affordable computer technology, but recent trends indicate that is changing.

    And it is still an open question as to how much or how little plan sponsors and money managers should use value at risk, a risk measurement methodology, in investment portfolio management.

    "The general derivatives paranoia has died way down," said Maarten L. Nederlof, vice president with Capital Markets Risk Advisors, a New York consulting firm.

    The risk management document produced by a group of mostly pension executives, called the Risk Standards Working Group, is gaining usage by plan sponsors, Mr. Nederlof said, whose firm coordinated the effort.

    Plan sponsors, at this stage, primarily are using the document as a means to perform self-assessments, Mr. Nederlof said.

    However, Ezra Zask, president of Ezra Zask Associates, Greenwich, Conn., said risk management practices still haven't taken hold very widely. As news of big losses in the United States quieting down in recent months, many are expecting the call for added risk management to just go away, he said.

    For the majority of investors that's a bad idea, he said, even for those restricting investments to uncomplicated stock and bond investments.

    Some institutional investors are likely to be out of the derivatives arena for quite a while.

    "Sometimes if you say derivatives, people just close their ears," said Stephen Pelletier, director of over-the-counter derivatives and portfolio manager for Analytic*TSA Global Asset Management Inc., Los Angeles.

    Nevertheless, there are other movements that seek to broaden the scope of risk management practices.

    The Global Association of Risk Professionals is creating a "Financial Risk Manager" designation, with the first exam slated for October.

    Lev Borodovsky, executive director of GARP and a risk manager for Credit Suisse First Boston in New York, said the FRM designation is not designed to be a comprehensive risk management certification, but rather the first step toward establishing risk certification.

    The examination essentially will act as a screening process for those in the risk management industry, Mr. Borodovsky said. The exam will be tough, but the goal is to address a fairly wide audience, including people on the investment management side.

    Moreover, sell-side risk management techniques continue to seep over to the buy side. Waite Rawls, chief risk officer for Ferrell Capital Management Inc., Greenwich, Conn., said some derivatives specialists from Wall Street are crossing over to the money management side of firms.

    "They're bringing a different vocabulary" and way of looking at risk that could have a major effect on how money management is performed, he said.

    But more near term, the cost and availability of technology continues to be a big issue for pension plan sponsors and money managers developing new risk management process.

    While big trading institutions such as banks and securities dealers have a history of using sophisticated risk management systems, institutional investors, with more limited budgets and different needs, have fewer technology choices.

    "Unfortunately, some of the good stuff is quite expensive," said Robert J. Baldoni, a partner in Ernst & Young L.L.P.'s risk management and regulatory practice. But he and others say technology is getting cheaper and more useful for long-term investors. Mr. Pelletier of Analytic*TSA said software companies are offering new products at more competitive prices.

    Aamir Sheikh, director of enterprise risk management services for BARRA Inc., Berkeley, Calif., an investment consulting and software company, said a problem for plan sponsors and money managers is the diversity of their risk management needs. Different investment tools might be needed for different investors, he said.

    Industry participants have not come to a conclusion on how pension and investment managers should use value at risk, which tries to put a dollar value on the expected losses a portfolio might experience under a given scenario.

    "I am a true believer in the concept," said Mr. Baldoni of value at risk. He said the common perception that VAR is most useful for banks and other large financial institutions doesn't hold true.

    Once VAR technology becomes cheaper and better applied to long-term investment management, it can take investment managers to the "next plateau" of risk management, he said.

    Manager-of-manager funds could be tremendous beneficiaries of value at risk, Mr. Baldoni said, because those funds need to control overall risk, he said.

    Others are more cautious regarding the concept.

    "I have mixed reactions on value at risk. It's not going to save the world," Mr. Pelletier said.

    "VAR is a nice risk measure, but it's not foolproof," he said.

    Mr. Zask said VAR is useful, and could have prevented all of the recent investment blowups, barring fraud, had it been used properly, but that's not generally the case.

    And, "if you take it (VAR) to be the end-all of risk management, you're in trouble," he said. Assumptions underlying the methodology are subject to change, which can change the results of the computed values at risk, he said.

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