Greg Vaughan: The hang up on process reinvention is peculiarly an obsession with quants. Researchers are content with a more gradual process evolution with conventional managers. Kristian Fok: To my mind, the quant managers – the ones that we use anyway – have always had some fundamental basis for the way that they put things together. This environment is fairly unique in terms of the dynamic of having to reduce leverage, compounded with asset prices falling. The normal view of risk is a little bit different, because we’re talking about the risk of total loss now.

Dennis Sams: At both manager selection and the fund structure levels, you really are trying to set up longer-term structures that are going to work over time. And that’s part of the perspective for quant managers. Just because of August 2007 it would have probably been a very bad mistake to react very negatively or very quickly at that point time. So you have to watch that short-termism. That’s a real risk for superannuation funds. Greg Bright: It seems like member choice has brought that short-termism to the fore.

Dennis Sams: That’s a danger we face with members. But how we actually control them and stop them making bad choices, is very difficult. Greg Bright: There’s a philosophical issue of whether we’ve gone too far with choice. Kristian Fok: It is a potential big issue for planning. Anyone who has to deal with liquidity and cash flows has to plan for things that may not happen. Which does reduce your capacity to take on things that may be hard to reverse in the short term. Greg Bright: Getting back to the risk processes of managers, Greg, you make distinctions between embedding risk controls within a process and kind of bolting them on.

What do you mean by that? Greg Vaughan: There’s a difference in how people build risk models. At the one end it’s a classical multi-factor fundamental-type risk model in the spirit of BARRA. Cutting through that we conceive of other common elements of risk that just aren’t vivid enough statistically or historically to really be picked up in that way. They may be topical, they may be transient, but they’re important and they can be implemented in a structured way but not necessarily statistically estimated in the same way that you can with other things.

Richard Dalidowicz: Greg, should clients have full access, full transparency? For example, Kristian would you want full transparency through their proprietary risk model? Kristian Fok: The responses we get are different for different managers. A lot of these things are very complex, so for us consultants to understand properly it’s very hard. So we ask for a bit of time and patience. Sometimes you actually go into a bit more of the detail when you finally say, “well you’ve got to bring us along a little bit here. But transparency is about information that’s useful to you. There’s no point in me looking at the code in the system, because I couldn’t understand what it is, but being able to understand how it’s put together is important. Everyone does the big headline factors and then you have to go through about 12 sub-factors and how they interact with each other.

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