The GFC has caused a rethink in so many fundamental aspects of institutional investing, but none more so than in the overlay of risk management principles and their implementation. A simple assumption, for instance, that was implicit in the way some institutional investors, in particular the big endowments, viewed liquidity was that you could always turn wealth into cash. We have learnt that this is not always the case.
According to Ben Golub, one of the founders of BlackRock, the crisis may have reversed the first rule of finance: “Rather than assume that the markets exist to give intrinsic value to assets, I think the reverse may be the case, that you won’t get value unless certain conditions are met, such as the markets aren’t working.” Golub is head of risk and quantitative analysis at BlackRock and a member of the firm’s executive and management committees.
He says that when BlackRock was formed in 1988 as a specialist fixed income manager, risk management was part of the original focus. “We wanted to bring sell-side technology to the buy-side in funds management. We wanted to identify the risks in products like structured mortgage products,” he says. The two early drivers were: know the risk; and the use of investment analytics and quantitative methodologies. This combined technical analysis with the internal distribution of the information to make it useful.
Later on, the managers looked at the implementation more closely and made sure that people were acting on the information, which required specialist risk managers. A specialist risk management group was established, which currently has about 90 people in various countries. These days, following the takeover of the former Merrill Lynch Investment Management, BlackRock applies its risk management across all the main asset classes.
On a recent visit to Australia, Golub said that prior to the crisis, investors became intellectually sloppy, especially in their assumptions about liquidity. In the initial phase of what was then just a crunch, the liquid markets were slammed. In the second phase, there was a big drop in the value of illiquids. Golub believes that, from an investor’s point of view, the likely scenario is a “long slog”. “If you bought equities just after the 1987 crash, within a year you were ahead of the game. But I don’t think this will be like that. There’s a lot of restructuring to be done.