It is almost impossible to predict  the day an asset bubble will burst, but  identifying and managing unsustainable  imbalances in markets can be done. A  number of fundamental and quantitative  inputs are required to achieve this,  Laubsch says.  “If you just purely rely on a model  it is like looking only at the GPS while  you are driving and not the road. Is it  raining? How heavy is the traffic? You  shouldn’t just believe the GPS – you  need to look outside.” 

But measuring risk is easier than  managing it at the portfolio level. The  job of a risk manager is to dictate “how  much is too much”, and when a portfolio  manager decides what to invest in, a risk  manager helps “size the bets”.  It also requires a professional  culture that sees risk as a source of opportunity  as well as a threat to performance.  For almost everybody, the subprime  mess has been a disaster.

But for some  hedge funds, it was an extraordinary  opportunity to sell short the toxic securitised  mortgage market.  “No matter how great models  are, if you don’t have a culture that  understands risk, and a proactive risk  manager, you will fail. The results  become lost.  “You can have great metrics and  risk people within an organisation that  doesn’t respect them, and when the  risk managers say no to a deal, they get  fired.” 

The problem wit h stayi ng  too close to home  One risk that superannuation funds  are particularly prone to is the concentration  of their exposures to Australian  assets, Laubsch says.  These allocations are excessive in  comparison to their investments in  international equities.  “Australia is a good market, but so  closely tied to the growth of China and  metal prices. China has started to slow  and commodities could go through a  bear cycle – do you want your retirement  savings to depend on the price of  commodities? 

“If resources perform poorly, this  will send shockwaves through the  Australian economy, precisely when you  need safety in your portfolio.  “Retirees will need their money the  most if the economy in Australia is not  good.”  Further diversification among asset  classes and trading strategies could lower  risk, but it would increase manager  costs. In crises, when all correlations go  to one, these expenses hurt as attempts  to diversify can be seen as being made  in vain. 

Still, “there was a big difference  between whether you held Goldman  Sachs or Lehman Brothers stock,”  Laubsch says.  “A lot of people have piled into  many of the same things at the same  time, such as infrastructure and property,”  Laubsch says.  “And if you’re in a herd it makes it  more dangerous because if that goes  down, and is driven down further by  investors getting out, that whole market  will hurt at a time when pensioners  need access their money.” 

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