From a recent discussion on LinkedIn, the following question was put forward: "What are some of the roles a risk manager should play at the public market / equity investment fund?".
In this short article, we'll take a look at the charter of a risk manager, and why not? Actually, let's quickly take a peep at the top risk management position in any firm, the Chief Risk Officer.
Depending on the size and structure of an investment fund, the position of a Chief Risk Officer (CRO) can be quite challenging as the scope of work is often varied, accountability for performance is highly visible and the firm's position can quickly deteriorate when an investment strategy moves off target.
"To make the question a bit easier - are there any other roles for the risk managers except setting limits and monitoring limits?" | Alexei Sidorenko
Jokes aside, monitoring limits and investigating the root cause of exceptions is just one of the daily duties a risk manager would be tangled up in, there is much more to the role as we shall see shortly.
The CRO position in any firm is generally influenced or perhaps shaped by the 'risk context' that emanates from the environment and processes that make up the core business of the entity. Consequently, the role of CRO in an investment fund is likely to prioritise different activities over the same position in an oil company or say an airline. To appreciate these subtleties, one needs to follow the flow of capital throughout the business model, and in an investment unit; activities are delineated into market facing work, which we refer to as The Buy Side [ LINK ] in the diagram below and The Sell Side [ LINK ] or street facing investors.
Figure 1 | The Role of a CRO in a Fund
Further more, to put gravity on the importance of the CRO role in an investment fund, a recently published AIMA article titled "Alive & Kicking" [ LINK ] has the CRO ranked as one of the most important management positions in the firm. Reading between the lines of "Alive & Kicking", executive management is likely to sell out the compliance team head, legal officers and even the human resources boss to some outsource process before they'd consider cutting the same fate for their beloved Chief Risk Officer. The Alternative Investment Management Association (AIMA) is an interesting association that reviews hedge fund best practices, and its publications are generally on the mark.
Figure 2 | Dedicated CROs
So back to our roles of the CRO and yes they do stretch beyond limit monitoring. To look at it differently, if I were asked what are the top twenty functions for the CRO in an investment fund, I would list the following activity centres below in no order of importance and squeeze in Risk Control Assessment at the very end. Mind you, putting it like that; one has to realise that I have probably de-emphasised the work that most people would expect from a traditional risk manager by throwing in Risk Control Assessment at the tail of this list.
1 Reviewing Outcomes from Buy Side Due Diligence
2 Credit Counterparty & Close Out Risk Management
3 Issuer & Sovereign Risk Monitoring
4 Market Risk Policy Design & Model Development
5 Limit Monitoring (can't forget that)
6 Risk Appetite & Performance Reporting (has a huge impact on investment fund practices)
7 Back Testing and Stress Testing
8 Operational Risk BCP
9 Liquidity Risk & Lock In Management
10 Supporting Compliance and Regulatory Responses
11 Developing & Acquiring IT Risk Solutions
12 New Product Reviews (buy side & sell side)
13 Reputational Risk Management
14 Conduct Risk Monitoring & Risk Culture (heavy focus these days)
15 Asset & Liability Management
16 Emerging Risk Identification & Assessment
17 Enterprise Risk Governance Framework Design (probably appears first in the list)
18 Strategic Risk Support
19 Risk Quantification & Model Design
20 Risk Training
21 Risk & Control Assessments (heavy focus for CROs outside the investment fund space)
When it comes to the challenges that a CRO may face in the investment fund space, risk culture and conduct risk features heavily and has done so since the Global Financial Crisis. Modelling tracking error, an important process that makes up part of the risk and performance reporting work, can also weigh on the CRO position. Compliance is a real killer in today's markets, the penalties are extraordinarily high and the cost to deliver a rugged business model that is also compliant runs at around 20% of the management costs for the entire business! That's crippling, and there seems to be no regulatory respite in sight.
So there we have it and do always feel free to share your thoughts.