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.
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.
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
We have to have wholesale regulatory reform. In the US, we’ll have to nationalise some
institutions, one way or another. Savings rates have gone up already. We will
have a nasty recession.” In some client presentations while in Australia,
Golub offered up his 10 main lessons for investors from the crisis.
They were: 1.
The paramount importance of liquidity 2. By the time a crisis strikes, it’s too
late to start preparing for it 3. ‘Certification’ (relying on bond insurers,
rating agencies and so on) is useless during systemic events 4. The importance
of counterparty risk management 5. Structured finance vehicles have raised
systemic risk 6. Investors in securitised products need to look through the
data 7. The market’s appetite for risk can change dramatically 8. The market’s
level of risk can change dramatically 9. Don’t let the market determine your
level of risk 10. The nature of risk may be changing.