“You have to trade the aggressiveness of a strategy against its liquidity costs.” He believes institutional investors need to flip the decisionmaking process when deciding to invest in these asset classes. “Generally if you are an endowment where you have a longtime horizon and there is no need for producing liquidity then it’s fine. But you need to look at what you need to produce in cash and then set asset allocation. Start with the nature of the institution and its requirements then the portfolio will flow from that.” By way of example Golub says he recently found out his motherin- law at the age of 82 had her assets invested 100 per cent in equities. “When I told her to have more a structured, diversified portfolio, she said she wanted to stay in equities because they would go up. I said historically that was true, they would go up, but I couldn’t tell her if she would still be alive when they did,” he says.
“This demonstrates the need to look at individual plans for their liquidity requirements and the financial characteristics of the institution.” In his paper Golub highlights the paramount importance of liquidity. The pair elaborate on the importance of liquidity as a risk management tool by emphasising that liquidity is a common risk factor, that cash and cashflow are the only robust sources of liquidity, that price does not include intrinsic value, that complexity and opacity matter more than you think, and collateralisation can be a two-edged sword. In addition to liquidity, the paper outlines other lessons for investors to consider as a result of the credit crisis including: that investors in securitised products need to look past the data to the underlying behaviour of the assets; certification is useless during systemic events; the market’s appetite for risk can change dramatically; make sure the market doesn’t determine your level of risk; the changing nature of market risk; and by the time the crisis strikes it’s too late to start preparing.
While Golub believes lessons are important – “if something happens it shouldn’t really just be something that has happened before” – he says risk management is not just about forecasting the future. “Another element of risk management under-appreciated is risk mitigation,” he says. “It’s important to have subject matter experts not attached to the portfolio decision making. This provides a different perspective but you can also use them to shift resources around. You can’t anticipate a ‘Black Swan’ but a good risk management team is a MASH unit for when they do occur.” One of Golub’s key areas of focus in the next year will be looking at the risk management around the legacy BlackRock and legacy BGI products, how to maintain the best of both systems as well as build a risk management framework on a firm-wide basis.