9/11 introduced new risk to money management

The investment management industry proved resilient in the 10 years since the terrorist attacks of Sept. 11, 2001, even though things can never be the same.

Even some of the money management firms hardest hit have survived and thrived.

Among them, Fiduciary Trust Co. International and Fred Alger Management Inc., decimated by the loss of 97 and 35 employees, respectively, when their World Trade Center offices were destroyed, will commemorate their lost colleagues for the 10th anniversary of the 9/11 attacks. (See page 3 for stories about each firm.)

Still, the money management industry didn't emerge unscathed from the tragedy: The attacks left a sense of vulnerability as a permanent and ugly scar, and forever changed the way the world thinks about investments.

“9/11 fundamentally changed the world's confidence that we're always on firm footing and that we will get through any crisis,” said J. Tomilson Hill, president and CEO of Blackstone Alternative Asset Management, New York.

“Before the attacks in 2001, there was a sense that governments, including the central banks, would always be able to figure out a solution to any problem. But we came very close to having the whole global banking system — the lifeblood of the global economy — close down. 9/11 contributed to the sense that the institutions we rely on are not always in control and that sense of vulnerability affects everything — markets, financial institutions, personal decisions,” Mr. Hill said.

That sense of vulnerability dramatically changed the perspective of market participants, sources said.

“There's no doubt that (9/11) had an indelible impact in terms of changing the way that we look at the world” and think about the connections that a more global environment has created in the 10 years since the terrorist attack, said Andrew W. Lo, a finance professor at the Massachusetts Institute of Technology and chairman and chief investment strategist of hedge fund manager AlphaSimplex Group, Boston.

While 9/11 wasn't the first incident that sparked a far-reaching flight to quality, it did mark “a coming of age of the kind of global integration that we now take for granted,” said Mr. Lo.

Since 9/11 there have been a number of instances in which “multiple asset classes became locked in correlation,” and that has “changed the way we think about risk management and investments,” he said.

Said BlackRock Inc.'s Robert C. Doll Jr.: “The world, especially the U.S., became a much riskier place after 9/11. There has been a semipermanent increase in the risk premiums investors now pay because 9/11 introduced risk we didn't have before.”

Mr. Doll said he has “no clue about the magnitude of this cost. It's impossible to quantify.” But he noted the new world order that emerged after Sept. 11, 2001, convinced him to factor geopolitical risk into his investment process.

“What are the wild cards? Everyone is more wary and aware that these risky events could pop up unexpectedly, but no one can anticipate what they will be or where or when they will happen,” said Mr. Doll, vice chairman, a director and CIO of global equities at New York-based BlackRock.

The 9/11 “wild card” did hammer home to money managers and institutional investors alike just how unprotected their operations were from a wide variety of threats beyond terrorism, including natural disasters and man-made problems such as strikes and power outages.

“The most tangible realization after Sept. 11 was just how unprepared Wall Street trading houses and the money management industry were for an event of this kind. 9/11 didn't end up moving markets on a permanent basis, but it changed how we all do business,” said Stephen N. Potter, president of Northern Trust Global Investors, Chicago.

Mr. Potter and others said the events of Sept. 11, 2001, unveiled dangerous new investment and operational risks and an industrywide realization that risk systems, business continuity plans, disaster recovery processes and system backups required massive upgrades.

“The events of September 2001 heightened awareness of the possibility of black swan events and definitely accelerated the industry's focus on risk management and better scenario analysis. Back then, very few managers were factoring terrorism or geopolitical events into their risk management systems,” said John S. Griswold, executive director, Commonfund, Wilton, Conn.

At Commonfund, risk managers now “sit at the main table” and are an important part of the firm's entire investment process. Risk managers also pushed for “a much longer investment horizon” to match the mandate of its endowment fund clients, he said.

Like many companies, Prudential Financial Inc., Newark, N.J., greatly expanded its business continuity planning after 9/11's “wake-up call,” said Charles Lowrey, chief operating officer for the U.S. businesses.

Prior to 2001, such plans were likely to focus on limited disruptions, such as how to respond if power lines to a company office were cut by a construction crew. After 9/11, suddenly people realized the need for “detailed, specific operating procedures” for an array of contingencies, Mr. Lowrey said.

The disaster planning of money managers of all sizes now includes multiple, remote, fully functional backup sites — either owned by the company or by a third-party provider — that can fully replicate the company's systems within a short time frame, said Sameer Shalaby, CEO of Paladyne Systems Inc., New York, which provides integrated technology to the money management industry.

Site locations are confidential and the buildings are unmarked and completely nondescript.

“Security of the data centers of these companies is extremely important and of huge interest to managers because the common belief is that the next big terrorist attack will be cyber. Investment managers are as concerned about cyber attacks as they are about physical attacks because both will disrupt their business,” Mr. Shalaby said.

He said institutional investors now conduct far more due diligence on their money managers' business contingency and disaster plans and are increasingly demanding documentation and evidence that those plans are functional.

The $30 billion Public School & Education Retirement System of Missouri, Jefferson City, is one such investor, said M. Steve Yoakum, executive director: “9/11 absolutely was the impetus that reminded everyone, very strongly, of our vulnerabilities.”

He said Missouri's teachers are completely dependent on the retirement system for their benefits because they are not covered by Social Security. All but a handful of those benefit payments are made electronically, so the fund's systems and all of its vendors have to be absolutely disaster-proof.

“We conduct very rigorous due diligence on the systems and backup plans of all of our vendors, including money managers and custodians, as well as anyone else we do business with, right down to the local bank that accepts our beneficiary's electronic payment,” Mr. Yoakum said.

Since 9/11, the fund moved its backup facility to a secure data center underneath a mountain in Branson, Mo., where its entire operation can be brought up within hours.

“Beyond the threat of terrorism, we've had floods in this state and a devastating tornado in Joplin. We have to be prepared for any kind of disaster, natural or man-made.”

Just how much impact 9/11 has had on the economic environment investors and money managers are facing now is a matter of contention.

Many observers argue the attacks shouldn't be seen as a decisive economic factor. For example, the spending that can be directly tied to Sept. 11 — the more than $1 trillion spent in Iraq and Afghanistan — is dwarfed by the outlays deployed to respond to the recession the U.S. economy fell into at the end of 2007, noted Gary Shilling, president of economic consulting firm A. Gary Shilling & Co., Springfield, N.J.

Some, however, believe the continuing ripple effects ultimately will prove considerable.

The 9/11 attacks effectively siphoned trillions of dollars from the productive private sector and into government spending — including homeland security outlays — with an accompanying step-up in intrusive regulations, noted Robert D. Arnott, chairman and CEO of Research Affiliates LLC, Newport Beach, Calif.

If the indirect effects of 9/11 — as a pronounced inflection point that focused attention on geopolitical risks at the expense of grappling with a range of severe economic problems at home — are added to the considerable direct costs of Iraq and Afghanistan, it's reasonable to see that attack as a “serious contributing factor,” if not a primary factor behind today's difficult economic outlook, added Christopher J. Brightman, a director and head of investment management at Research Affiliates.