US EAST COAST 2012 - HFMWeek

US EAST COAST 2012
THE REAL RISK OF
FAKING IT
DID THE INDUSTRY LEARN FROM THE 2008 CRISIS ARE RISKS BEING PROPERLY MONITORED OR ARE WE DESTINED TO HEAD INTO
THE SAME STORM AGAIN DAMIAN HANDZY, OF INVESTOR ANALYTICS, TALKS TO HFMWEEK ABOUT THE REAL COSTS OF NOT
ANTICIPATING AND MANAGING RISK
Damian Handzy,
CEO, co-founded Investor
Analytics in 1999 to provide
risk management services
to the alternatives industry.
He was named chairman
and CEO in 2006 and has
grown Investor Analytics into
one of the global leaders
in risk analysis and risk
management solutions.
18 HFMWEEK.COM
Damian Handzy, the CEO of Investor Analytics,
observed in a recent white paper
that the financial crisis served to remind
us that a free market provides the means
to win and to lose – but he added that not
all financial managers followed the major
markets into free fall in the aftermath of 2008. The managers
who successfully navigated the crisis, said Handzy,
understood and acted on the three tenets of risk management:
(1) all risk models have built-in assumptions that
are not applicable in every circumstance; (2) correctly
analysing the data takes real expertise; and (3) model
limitations can only be ignored at great peril. HFMWeek
spoke to Handzy recently to get his views on the current
state of risk management – have managers reset their approach
to risk management or is there still over-dependence
on models as a substitute
HFMWeek (HFM): Given the number of financial
events that have happened, even since 2008, do you
think managers learned some real risk management
lessons
Damian Handzy (DH): The real question is, did we learn
any lasting lessons I hope we did, but as a student of human
behaviour, I know that we all have selective memories,
which is why we often have to repeat our mistakes to
learn from them. When times are good, it’s our nature to
want to believe that what goes up will keep going up even
though we have a mountain of evidence to contradict
that notion. In 2008, we were reminded once again of
the very high cost of ignoring history, a mistake that still
haunts the industry. However, the
events did open up a healthy and, I
believe, lasting dialogue about the
importance of real risk analytics
and management versus just having
models that measure various
statistical outputs.
IN 2008, WE WERE
REMINDED ONCE AGAIN
OF THE VERY HIGH COST
OF IGNORING HISTORY,
A MISTAKE THAT STILL
HAUNTS THE INDUSTRY
”
HFM: Was ‘don’t put all your
eggs in one basket’ better risk
management
DH: The multiple basket approach
only works to a degree.
The idea behind it is, of course,
diversification, which requires uncorrelated
investments. But during
a market event like 2008, almost every investment
became very highly correlated with everything else. As
a lot of assets become contaminated, the opportunity to
diversify was reduced.
That’s where hedging strategies and stress testing
come into play. In this case, what you’re stressing is
model assumptions – like correlations – to measure the
portfolio’s risks in highly correlated markets. Stressing
correlations is key to understanding how well diversified
the portfolio really is. At Investor Analytics, we’ve been
providing stress testing as part of our system for years.
The ‘correlation goes to one’ stress is simple to understand
and provides a lot of useful information.
HFM: What is the highest barrier to companies adopting
a risk management culture
DH: There are both cost and human factors at play in
the decision to integrate more robust risk controls. First,
we are in a challenging economy where everyone is being
asked to contribute more with less and where resources
are scarce. An existing risk system, whether built inhouse
or purchased in the past, may seem like a low-cost
approach if the direct expenditure is low. But that lowcost
system is probably not scalable or capable of handling
today’s portfolios or markets.
Possibly even more important is the human factor –
who is going to control the risks taken by the portfolio
managers Who is going to have the authority to tell a
portfolio manager to de-lever or reduce risk if they are
exceeding thresholds A risk management culture starts
with – or dies from – the top. If the head trader or CEO
doesn’t buy into a risk management
culture, it’s difficult to implement
such a system effectively.
HFM: What are the biggest challenges
facing your clients
DH: Certainly there has been a
significant change in the number
of stress tests being conducted
and the depth of detail that investors
and regulators alike are now
demanding. For example, the
SEC-mandated Form PF now requires
certain hedge funds to submit
on a regular basis analytics for
a variety of stress tests in addition