This function cannot be simply outsourced, as risk management and portfolio management are two sides of the same coin. In contrast, it makes sense to outsource the risk measurement function to external service providers, as setting up the required infrastructure in-house would be costly. Specialised providers have a head start because of their continuous investments in data collection and preparation, models, reporting tools and staff.

Some companies have tried to let their in-house risk management units fulfil the risk measurement function. As a consequence, teams of risk managers spent most of their time collecting and evaluating data. In some cases, it actually took several months before companies were able to create complete transparency in their securities portfolio and its risk exposures. In contrast, whoever uses a specialist external service provider is able to achieve, in a timely manner, the level of transparency essential for effective risk management. Competent providers also assist in the solving of technical problems when inspecting portfolios and products, for example, where various capital market products are managed across different platforms. It is certainly helpful when the financial institution’s technology or information managers ensure that the technical infrastructure facilitates an inspection of all portfolios and products. This of course costs money, and one thing is clear: risk management and risk measurement don’t come free. It would be a mistake, though, to view these functions solely as net cost items, independent of alpha generation. Portfolio management and risk management are two sides of the same coin and, over the long term, one side can only function when the other side functions. This realisation is now slowly catching on, as the market for risk management services continuously grows.

A good risk manager follows an approach that is not too focused on individual parameters, as the individual risk measures depend on the specific perspective and the underlying instruments. For instance, while structured credit products (such as collateralised debt obligations) are exposed to an interest risk, their prevailing exposure is credit risk.

These multiple risks must be appreciated in their interrelationships, while at the same time understanding the relevant risk models and their respective limits. As the past few months have demonstrated, this requires risk managers to possess a high level of intuition. Many of the models used are no longer suited to analyse the capital market products, newly developed in the course of the US mortgage boom, as they are based on extremely limited data sets. Some organisations have been far too focused on potential crisis scenarios in individual market segments over the past few months. The fact that virtually all market segments took a dive in unison caught them unawares. During this phase, those companies who recognised the importance of risk management and measurement early on and acted accordingly will have an edge. This has been a painful experience for those financial institutions who failed to learn this lesson.