The right internal structure for institutional risk management is a function of scale. According to veteran career risk manager, Ben Golub, vice chairman and chief risk officer of BlackRock, most people believe the premise that risk management is a good thing, but may not be prepared to pay adequately for it. “One story not told about risk management is that good risk management is expensive,” he says. There are of course a number of ways to manage that expense, one of which is to have a less-needy portfolio, such as a vanilla asset allocation with a heavily weighted passive allocation. “Risk management becomes a much bigger issue when you get into extensions on the types of portfolios such as alpha transport, hedge funds, private equity, and those that create increasing complexity in pursuit of higher alpha,” Golub says. If you are large enough the cost for strong risk management can be less of a burden.
“It is imprudent to assume you get that alpha for free. You need to scale support to prudently service the portfolio.” Golub says the credit crisis highlighted the rapid evolution of the complexity in products that in some instances went beyond the capacity for participants to risk manage. “Institutions need to be realistic, if they pursue more highly complex structures and products, then they need to consider that additional organisational risk management costs associated with them.” Golub was one of the eight original partners who founded BlackRock in 1988 with the aim of bringing sell-side analytics to the buy-side and forming a boutique manager managing complex mortgage securities. Now he heads the risk management team of 140 people who manage the risk across all products as well as counterparty and operational risk of what is now the world’s largest asset manager.
Golub recently co-authored a paper with colleague Conan Crum, associate, risk and quantitative analysis at BlackRock. Entitled ‘Risk Management Lessons Worth Remembering From the Credit Crisis of 2007-2009’, the paper highlights the inadequacy of many standard methods in quantitative risk management during that period. Personally, Golub says he was surprised at how many aspects that arose out of the credit crisis stressed the paramount importance of liquidity. “Someone said liquidity is like oxygen, you only notice it when it’s not there. It’s like when you go to a hotel and turn on the light you don’t say ‘this is a nice hotel’,” he says. “Financial markets are a utility to convert wealth assets to cash, and during the financial crisis that utility failed and institutions couldn’t convert wealth to cash. There was tremendous complacency about that issue.” Part of that complacency, he says, centres on the proliferation of hedge fund, private equity and unconventional assets used by institutional investors. While a lot of analysis was done regarding correlations and returns of those asset classes, none of the analysis mentioned the lack of liquidity.