Good Risk Governance Pays

Good Risk Governance Pays

Investment Best Practices | Risk Management | Valuation

“Sully” Movie Rightly Addresses Importance of Experience

Posted in Model Risk, Risk Management

B737 Flight simulator

It’s no wonder that Sully is having a boffo opening weekend. Directed by Clint Eastwood, this Hollywood version of the emergency water landing of a large jet with 150 passengers and 5 crew members tells a tale of calm under pressure and incredible bravery. You may have watched the unbelievable January 15, 2009 real-time footage that showed people standing on the wings of the damaged plane as it sank into the icy Hudson River. Perhaps you clapped as New York City boat operators and helicopter pilots pulled everyone to safety with lightning speed. Surely it was a great day in the Big Apple. Everyone was chatting about the “Miracle of the Hudson.”

While the film (based on the bestselling book) spins a riveting tale of a disaster averted and the investigation that followed, it also reinforces important concepts that apply to the world of risk management – Experience, Team Work and Decisiveness. During an inquiry by the National Transportation Safety Board, the point was made, based on flight simulation results, that Captain Chesley “Sully” Sullenberg and First Officer Jeffrey Skiles had sufficient time to return to LaGuardia Airport. As the movie progresses, the Sully character (played wonderfully by Tom Hanks) explains why it is inappropriate to assume that he and his colleague would have been able to instantaneously assess the situation and immediately return to the departure gate. When the simulations are repeated, this time adding thirty-five seconds to allow for the reality that humans are not robots, faux crashes occur. The implication is that the Hudson landing was the right thing to do.

During an interview with actress Laura Linney about her role as Sully’s wife, she affirms this message that “Experience counts – more than a computer simulation, more than an algorithm. Actual human experience is a valuable thing …” I heartily agree with her. Notably, Mr. Eastwood is still working his inspirational magic at the age of eighty six, sharing his experience with moviegoers around the world.

Throughout my career, I’ve seen upfront and close how certain markets don’t behave as expected or models may falter when surprise exogenous shocks occur. Seasoned and knowledgeable professionals who understand the limits of an auto approach and use their judgment should be commended, not impugned. I have often said that risk managers need to spend serious time in the field and not rely on textbooks alone. Unanticipated stuff happens.

The true account and its celluloid depiction likewise lend credence to the importance of working together as a team and avoiding paralysis by analysis. The real life Sully has always credited his colleagues, including three well-trained flight attendants and of course the co-pilot (played with panache by Aaron Eckhart). During his sit-down for CBS, Captain Sullenberger said of the first responders, “Thank you seems totally inadequate. I have a debt of gratitude that I fear I may never be able to repay.”

To anyone who enjoys popcorn and drama, Sully is a must-see but go too for the poignant reminder that kindness counts. I don’t know if its release this weekend was by design but the film debuts when millions around the world mark the fifteenth anniversary of the 9/11 attacks on U.S. soil. Shortly after those horrific events, I visited the Wall Street areas where I had gone to graduate school and worked. The devastation was heartbreaking. Going in and out of Grand Central, it was no less sad to see photographs of missing persons, posted by worried family members and friends. I agree with The Wrap reporter Beatrice Verhoeven who describes Sully as “a joyful story – one that evokes 9/11 without its tragedy” and “celebrates the heroism of first responders without forcing viewers to re-live the agony.” Let’s remember them all.

Wall Street Ethics

Posted in Compliance, Ethics

Business woman writing business ethic concept. Blue background.

I’ve been waiting to see Equity since I read about the project a few months ago. I like films about business and this one has received lots of attention because it is written, produced and directed by women. The story about taking a technology company public was interesting enough and the sub-plot about life in the Wall Street fast lane brought back memories of my time on various trading desks.

Anna Gunn of Breaking Bad fame did an admirable job of conveying Naomi Bishop, a smart and aggressive investment banker who likes power and financial independence. According to one of the creators, Amy Fox, “Naomi did not get where she is by being nice … Spending a year living the voice of Naomi and the other characters of Equity has reminded me of my own capacity for strength.” I applaud this message. Professionals, whether men or women should strive for professional excellence with confidence.

Where I disagree with the filmmakers is the idea that dishonest people are frequently rewarded and ethical persons are not. In this celluloid version of Wall Street, a top broker provides what seems like material non-public information to a fictitious hedge fund manager who is willing to take short cuts to profit big. A mid-level female investment banker sabotages Naomi’s deal and ends up moving up the ladder of success after Naomi is fired. A female regulator pretends she is a ditzy bar hound, luring a trader to spill the beans about how he talks to insiders for “edge.” The CEO of the technology company fires an employee, prior to the Initial Public Offering (“IPO”), because she identifies problems with the product that is being hawked as a fail-safe protection of private data.

For sheer entertainment, Equity is a fine way to spend ninety minutes. As a career lesson, I’d urge you to look elsewhere. While true that not every miscreant is brought to justice, a continued emphasis on compliance, governance and business ethics makes life more difficult for those who engage in questionable acts, whatever their gender.

Investment Management Delegation Challenges

Posted in Compliance, Fiduciary Liability, Investment Consultants, Investment Management, Risk Management

Responsibility word on ribbons in a ball or sphere to illustrate passing or delegating duties, jobs, tasks and assignments to others on your team

Chief Investment Officer describes the surge in delegated management activity as “staggering,” noting a nearly nine hundred percent rise in discretionary assets in recent times. Of the 188 asset owners that were questioned as part of a 2016 survey, many cited “better performance as being either ‘critical’ or ‘important’ to their decision to outsource…” Other findings suggest a willingness to authorize third parties to appoint asset managers for at least a portion of an institution’s portfolio.

In response to what appears to be a fast-growing slice of the investment management industry, organizations such as UBS, Willis and Wilshire are expanding. However, not everyone is sanguine about the merits of saying “here, you take over.” According to persons interviewed for “Explosive Growth, Quiet Fears,” the selection and oversight of an Outsourced Chief Investment Officer (“OCIO”) should be handled by knowledgeable internal staff. The problem is that more than a few pension funds, endowments and foundations are turning to the OCIO model precisely because they are under-resourced. This begs an important question.

“Who is keeping tabs on the outside vendor?”

As I’ve described elsewhere, disputes between delegated third parties and asset owners can (and do) occur when there is ambiguity about who does what and/or conflicts of interest exist. Without an independent watchdog to scrutinize OCIO actions (including its governance and operational controls), it could be harder for an institutional investor to detect and address problems before a major loss occurs. Coupled with an increased regulatory focus on fiduciary best practices, it should be no surprise that neutral organizations that do not manage money will be increasingly asked to vet those that do.

Investment Risk Management Goal Setting

Posted in Foreign Currency, Investment Management, Risk Management

Fortune Cookies

Imagine my surprise when I opened a fortune cookie this week to read “You will find what you lost but first you must remember where you left it.” At first blush, the words don’t seem to make sense. However, I have had luck in being reunited with errant umbrellas, hats and so on by retracing my steps. The lesson learned is to keep a better grip going forward, leading me to write today’s blog post about the importance of investment roadmaps.

It is true that knowing what you want to achieve is paramount when it comes to investment management and related risk control. While it is not always straightforward to identify the unknowable with exact precision, it is possible to create parameters about what you want to avoid and blueprint accordingly. For example, some traders and corporations hedged against a drop in the British pound several weeks or months ahead of the BREXIT vote to stay or leave the European Union. This kind of tactical activity makes perfect sense for an investor with a strategy to minimize significant foreign exchange volatility and a commitment to ongoing analytical analysis to support decisions about hedge size, hedging instrument and choice of counterparty when the “right” time comes.

Although used often for purposes of evaluating employee performance, SMART goals that are Specific, Measurable, Achievable, Relevant and Time-Bound can apply to investment management and the containment of uncompensated risks. A realistic and relevant objective(s) must be identified at the outset, accompanied by an awareness of “worst case” events (to the extent possible) and risk control restrictions. Appropriate metrics must be likewise identified with the understanding that the process of risk mitigation is ongoing even though interim actions such as financial reporting and trade rollovers occur.

The BREXIT hedgers acknowledged their goal of avoiding currency depreciation and then implemented positions to reflect what they were allowed to do and how much protection was deemed necessary. Those who work in a regulated environment know that legitimate (versus rogue) trading takes place only after various authorities (such as trading limits and operational processing) are approved and functional.

As the distinguished writer Ray Bradbury said “Living at risk is jumping off the cliff and building your wings on the way down.” For asset managers and other stewards of other people’s money, a careless attitude towards risk-taking is likely to spell trouble later on.

BREXIT and Trust

Posted in Governance, International Investing

Managing risk business challenges uncertainty concept. Elephant with giraffe walking on dangerous rope high in sky symbol balance overcoming fear for goal success. Young entrepreneur corporate world

Like so many, I stayed up late to watch the vote count about whether the United Kingdom should remain part of the European Union (“EU”). With a margin of about 4% or 1.3 million people, “Leave” won the day, despite financial market trades that reflected an expectation to stay. Whatever your preferred outcome, it was certainly exciting to watch “people power” in action and learn more about our neighbors overseas.

No doubt there will be post-mortems by economists, political pundits and pollsters about what led to the British exit from the EU or “BREXIT.” Already, U.S. broadcasters in these early hours of June 24 are drawing inferences about what this historic decision might mean for our upcoming presidential election.

What caught my attention was a Financial Times column by its associate editor Michael Skapinker. In “Two nations but only one trusts business and its allies” (June 22, 2016), he describes opinion poll numbers that reflect a seriously low level of trust in what business executives, economists and those at the International Monetary Fund or the Bank of England have to say. His view is that “None of this is surprising,” due in part to banking and corporate scandals that have eroded Joe Everyman’s confidence in various institutions. What he did find “riveting” was a clear dichotomy between trust levels and how respondents planned to vote on the June 23 referendum. “Remainers” declared a high level of trust. The opposite was true for those in the other camp. Even academics who had little to do with the BREXIT discussion were given short shrift by the “leavers.” His major concern is that doubters don’t engage and are “far harder to win over” when asserting that businesses should not be heavily reined in through regulation.

There is a lot to be said about this concept of broken trust and what commercial and political organizations need to do to assuage fears of those who have been either spurned or were non-believers from the start. This is especially apropos when bad news can travel around the world in seconds, a grumpy customer can influence thousands of people with a single Tweet and a protester needs only a poster board and a magic marker to convey an impactful message. The good news is that there is so much that can be done to showcase leadership and integrity when it exists and there is no time like now to act.

Fiduciary Rule Panel to Discuss Implementation

Posted in ERISA, Investment Management, Regulation, Susan Mangiero

3D illustration of FIDUCIARY title on Legal Documents. Legal concept.

Dr. Susan Mangiero will join a panel of esteemed experts to talk about the U.S. Department of Labor’s Fiduciary Rule on June 21, 2016. Sponsored by the Financial Women’s Association, New Jersey chapter, CPE credit is available (CLE credit is pending). Meeting at the Seton Hall School of Law in Newark, this timely event features the following speakers:

  • Gregory F. Jacob, Esquire – Moderator – Former Solicitor of the U.S. Department of Labor, Partner in the Washington, DC office of O’Melveny & Myers and a member of the Financial Services and Labor and Employment Practices;
  • Susan Mangiero, PhD and Accredited Investment Fiduciary Analyst – Panelist – Forensic economist, investment risk governance expert and author/researcher with a focus on ERISA and non-ERISA fiduciary best practices;
  • Kathleen M. McBride, AIFA – Panelist – Founder of The Committee for the Fiduciary Standard and The Institute for the Fiduciary Standard, a nonprofit, nonpartisan think tank dedicated to providing research, education and advocacy on the fiduciary standard’s impact on investors, the capital markets and society; and
  • Margaret Raymond – Panelist – Vice President of T. Rowe Price Group, Inc. and T. Rowe Price Associates, Inc. and managing counsel with a focus on legal matters relating to retirement savings, including ERISA fiduciary principles and other retirement plan administration topics.

Some of the many topics to be addressed include the following:

  • Features of the Fiduciary Rule and how different market segments are likely to be impacted;
  • Past, present and future characteristics of the IRA marketplace;
  • Use of robo advisors;
  • Product availability and asset allocation, post regulation; and
  • Legal challenges being filed to forestall the implementation of the DOL Fiduciary Rule.

For further information and to register, click here. A special thanks to Dr. Dubravka Tosic and Attorney Gregory Jacob for putting this event together and arranging for continuing education credit.

Note: This event did not occur and will be rescheduled for a date this fall.

Risk Management “What If” Focus

Posted in Risk Management

Cardboard businessman walk straight into the abyss. Business concept

In watching television news this weekend, I am reminded that not everyone understands the proactive nature of risk management. I’ve heard the mantra before. “Why did I buy insurance? A year came and went and nothing happened. I could have saved the premium.”

The problem with this thinking is that no one has a crystal ball. It’s impossible to know with certainty what could happen. The goal of effective risk management is to ask what could go wrong and then assess both the likelihood of occurrence as well as the economic downside should that adverse event occur. What typically follows would be a ranking of worst case “what if” situations and deciding how best to mitigate potential problems.

As I wrote in Risk Management for Pensions, Endowments and Foundations, “… informed and proactive investors have a chance to meet or exceed return targets while minimizing capital exposure, if they do their homework and stay focused on the fact that things can and do change.” Robust risk mitigation helps to stabilize returns. Without it, the value of any or all holdings could free fall or wildly zigzag with little chance of recovery.

Yes, it is true that a risk management process is going to cost something to implement. The central question is whether one can afford not to manage risks.

Victoria’s Secret and Financial Benchmarking

Posted in Disclosure and Transparency, Investment Management, Risk Management

Red Lips_Smaller

Its iconic fashion show won’t occur until this fall but Victoria’s Secret is in the headlines for another reason. Owner L. Brands, Inc. (“LB” ticker) will no longer mail about 300 million catalogs each year. The goal is to save between $125 to $150 million and be more eco-friendly. Shoppers can still purchase online or visit one of 1,164 shops in the United States and Canada (and internationally via retail partnerships). According to Ad Week, earlier experiments in reducing snail mail did not materialize in a drop in sales. Besides, the company’s Twitter profile shows a beefy 9.64 million followers which no doubt helps to contribute to the bottom line.

Catalog news aside, I’m thinking about this $7+ billion sales engine today for another reason. Having just bought one of their sports tops, I was seriously surprised to get it home and realize how small it was for a size that ordinarily fits. Mind you, we’re not talking about a smidge too tiny but something more in the realm of “This item must have been incorrectly tagged.” Kudos to the local store as I had no problem returning it for full credit the next day although I had to take time out of my day to visit a second time. While I am unlikely to buy clothing there again, I do like their scents and they are size-free. As an aside, clothing sizes vary across retailers and over time so I’m not picking on Victoria’s Secret. See “The absurdity of women’s clothing sizes, in one chart” by Christopher Ingraham (The Washington Post, August 11, 2015).

Applied to finance land, the issue of labeling is at the center of more than a few calls for more transparency. On April 15, 2016, the U.S. Securities and Exchange Commission (“SEC”) made public a 341 page concept release, requesting comments as to how best to modify disclosures about items such as core company information, off-balance sheet arrangements, liquidity and capital resources, operating results and risk management. In other words, much of the data that investors would typically review before making a decision to buy, hold or sell a company’s securities is subject to possible change. Part of a Disclosure Effectiveness initiative, this financial regulator seeks feedback about ways that individuals and institutions can be better informed.

Certainly it is a good thing to provide access to reliable data and an accompanying narrative. However, more information is not always the same thing as helpful information. This is particularly true if a metric is misleading or incomplete or both. To illustrate, inputs put forth so far about how to improve current risk management reporting suggests dissatisfaction and a perception that filings are overly broad and should be refined. Comments include requests to present risk factors by entity, materiality and likelihood of occurrence.

With another sixty days before the SEC’s deadline, it’s too soon to know exactly how disclosures will change. Fingers crossed that reforms will address proposals made by knowledgeable persons to ameliorate any deficiencies.

Reputation and the Investment Management Bottom Line

Posted in Customer Service, Disclosure and Transparency, Governance, Investment Consultants, Investment Management, Key Person, Risk Management

Brand loyalty check mark image with hi-res rendered artwork that could be used for any graphic design.

Those in the know understand that both qualitative and quantitative factors must be evaluated when estimating enterprise value. The list of appraisal considerations is too long to address in any one discussion. Suffice it to say that one should understand, measure and benchmark multiple facets of an organization’s business such as production processes, distribution channels, sales infrastructure and customer service. A clarity about the industry in which a business operates is likewise essential. Who are the competitors? What regulations prevail and how is the industry responding to new mandates? Are industry sales sensitive to changes in global or local economic conditions? Is the industry poised for growth or fast reaching its apex?

Turning the microscope to narrowly focus on a single company, it would be remiss to ignore the economics of its brands and reputation. An organization’s customer base can reward shareholders if net sales grow and add to free cash flow. On the other hand, disgruntled buyers can decide to go elsewhere or seek redress in a court of law. Both outcomes are costly and can lower share value. Notably, the damage associated with a lost sale can vary depending on how long it takes to recover, if possible at all. For example, a money manager that loses a large institutional client will be reinvesting a much smaller pool of capital over the ensuing months. Should other long-term consumers like peer pension plans get wind of bad news, they too may exit, causing the asset manager’s portfolio to plummet further.

It’s not remarkable then that new research concludes that “high firm and product awareness – or together, brand awareness – could lead to greater retained assets and new inflows.” Nevertheless, the message is one that bears repeating given the significance. While its 2016 survey affirmed the link between reputation and financial wellbeing, eVestment uncovered some startling trends too. They are summarized below:

  • Institutional consultants review “less than two strategies per asset manager within a quarter.” This low number makes it hard for any particular firm to stand out by virtue of its brand.
  • Institutional consultants in search of “a level of manager diversity” may not be swayed by a multitude of products offered by a larger vendor and instead focus on satisfying other goals.
  • Awareness of larger asset management firms is not always an advantage. Survey results “showed managers with the highest brand awareness averaged outflows 4.5 times larger than inflows.”
  • When a key person departs, the downside outweighs the upside of “the hiring of an equally reputable star portfolio manager.” If this is true beyond the survey sample, asset managers will want to be fully transparent about any events that might be perceived by institutional clients (or their consultants) as negative.

For details, read “Why Asset Manager Reputation Matters” (Chief Investment Officer, May 19, 2016) or download the white paper entitled “Importance of Brand Awareness” from the eVestment website. As Warren Buffett declared, “It takes 20 years to build a reputation and five minutes to ruin it. If you think about that, you’ll do things differently.”

Dev Patel and Jeremy Irons Showcase Math Genius in New Film

Posted in Fun, Investment Management

Maths formulas written by white chalk on the blackboard background.

If you get a chance to view “The Man Who Knew Infinity,” go for it. Award-winning actors abound in this tale of math wits at Cambridge University who contributed dozens of important ideas that are still being used in business and science. Dev Patel, stars as the self-taught math genius, Srinivasa Ramanujan, who rose from poverty to team with world-renowned scholars such as Bertrand Russell and John Edensor Littlewood. Based on a book of the same name by Robert Kanigel, this biographical tale of talent writ large examines the unlikely friendship between Mr. Ramanujan and his mentor, Professor G. H. Hardy (played wonderfully by Jeremy Irons), the uncertainties of a war torn England and the dire loneliness of the young man who left his home in India to share his insights about numbers.

Sadly, Mr. Ramanujan died in his thirties, leaving a legacy of path-breaking equations that have since been proven right. According to a 2012 article in Business Insider, his work is used by physicists to compute “the entropy, or level of disorder, of black holes.” Last month, the founder and CEO of Wolfram Research, Stephen Wolfram, reviewed Hollywood’s take on this band of merry mathematicians and pondered how they could have saved countless hours had they had access to his Mathematica product that is used by many Wall Street quants. His admiration for this driven wunderkind is obvious, as is his hope “that many more people will take advantage of the tools we have today to follow Ramanujan’s lead and make great discoveries in experimental mathematics – whether they announce them in unexpected letters or not.”

Popcorn aside, The Man Who Knew Infinity is captivating and well worth a trip to the cinema.