BOSTON -- Risk management permeates all aspects of the investment process and value-at-risk is an important tool in measuring risk, according to several speakers at the Risk 99 conference.
Peter Bernstein, author of the best-seller "Against the Gods," said the "obsession with risk today" is due partly to "the new economy of the 1990s, which is capitalism unleashed. Risk is the driving force in capitalism. (People) make big bets on unknown outcomes."
At the conference held earlier this month and sponsored by Risk magazine, Mr. Bernstein pointed out that "the safety net's shrunk. The government's not there."
Moreover, he said, "the sink or swim society increases risk to the capitalist system."
In the corporate world, he noted, "there is huge compensation, but also huge insecurity.
"Clients know a lot more today. They have high expectations for risk management. (Companies) must be state of the art or out of business.
"The focus on risk management didn't blossom out of nowhere. There's nothing to slow it down --only a major recession or a war could hurt it."
"Everyone plays a role in risk management," said Steve Fierstein, senior financial analyst at GE Investment Corp., Stamford, Conn. "It permeates all aspects of the investment process."
Asset allocation, manager selection, trade execution/compliance and portfolio performance measurement all play a role in risk management, he said.
Value at risk is a piece of the risk management operation. "You can use VAR as a security system," he said. It provides a consistent quantitative measure of portfolio risk. It allows a fund to measure risk accumulation across asset classes and see where risk might be accumulating that the manager hadn't intended.
VAR also allows pension funds to identify potential "hot spots" in a portfolio and to measure risk-adjusted return.
He explained VAR as "the amount of loss a portfolio could sustain given a specific statistical probability over a specific holding period."
At GE, he gets a biweekly executive risk summary. Mr. Fierstein uses Bankers Trust Co.'s standard portfolio risk reports, which show risk by manager and/or account. They also show risk by risk-type (e.g. interest rate or currency risk). BT also provides a portfolio sensitivity analysis and access to its risk analysis team.
Mr. Fierstein admitted that "getting senior management comfortable with VAR is hard." A company must "know why you're using VAR and get a vendor with good customer support. Make VAR a process, not just a report -- define the users; establish responsibilities and create a feedback loop to drive actions."
For Eric Stubbs director of strategic advisory of Credit Suisse Asset Management, New York, "using VAR as a signal for rebalancing (a portfolio) appears to improve performance. "The biggest unsolved business problem in risk management is what to do with the information. Alternative strategies for risk management: rebalance as absolute VAR breaches pre-set bounds; and budget expected tracking error to improve aggregate manager performance. The two biggest challenges in risk management are: linking risk measures to performance attribution; and determining how a sponsor/manager should respond to unanticipated changes in risk profile."
Wayne Kozun, portfolio manager at the Ontario Teachers' Pension Plan Board, Toronto, said his plan uses management effect at risk, a variation on VAR. This is "the most relevant risk (measurement) for a portfolio manager. MEAR is a method of consistently measuring risk across different portfolios and asset classes. It is a much more sophisticated measure than others. This is the primary risk control (measurement) used by Ontario Teachers, replacing measures like duration."
To calculate VAR, which it also uses, Ontario Teachers uses 14 years of data. The long time period, he said, "keeps volatility relatively constant. (Pension plans) should use consistent volatilities in risk systems and asset-liability models if (they) have a long time horizon."
Robert P. Sullivan, a partner in PricewaterhouseCoopers, New York, talked about "using risk management as an offensive tool to help portfolio managers." According to Mr. Sullivan, the goals of a risk management program should include:
* Provide consistent risk measures across portfolios, asset classes and strategies including scenario analysis and stress testing;
* Manage risk appetite across client and fund family focused on longer-term performance measures;
* Provide assessment of overall risk exposure and interrelationships between risks; and
* Support current and new market and credit risk related restrictions including absolute and relative VAR.
