Category: Financial Risk Management
Looking For Risk In All The Wrong Places….
…was lookin’ for risk in all the wrong places, Lookin’ for risk in too many faces, searchin’ their eyes and lookin’ for traces of what I’m dreamin’ of. -Lookin’ for Love, Johnny Lee Risk will surprise you. It is supposed to do this. While we always think of volatility as risk, the real measure of risk […]
Met Few Good Traders Who Thought Their Correct Decisions Were About Luck
Skill is what you have when things go right.
Luck is what you don’t have when things go wrong.
Probability does not have a personality.
What Money Managers Can Learn from Waffle House
If you have been on the road looking for cheap food 24 hours a day in the South, you have likely been to Waffle House. It is not the best breakfast, but it is a good place for a quick meal. You usually will not see a money manager or a Wall Street banker at […]
Rivals Take More Risks – Is This A Good Thing For Money Management?
You might think some research is obvious after the fact, but in reality, good research can allow us to deepen our understanding on a topic and may provide subtle insights that were unexpected. One topic of interest is competition and rivalry.
If You Want to Understand Overall Credit Spreads, You Have to Have Both a Macro and Micro View
If you want to understand overall credit spreads you have to have both a macro and a micro view. The macro view looks at the business cycle and the chance of default for risky assets based on economic growth. The micro view looks at the credit supply coming to market, the demand for loanable funds at any time, and the structure of deals. The macro focuses on credit risk expectations and the micro will be more centered on the flow of funds. A macro-micro framework helps focus our interest in actual and perceived credit dislocations.
VaR – Good for a Manager, But Bad for the Markets as a Whole – Call it the “Paradox of VaR Risk Management”
So if there’s a big market sell-off and as a response the VaR overreacts and shoots up, then many investors are kind of forced to sell because they have to stay within their VaR limits and this selling will then be done in an already collapsing market…rigorous use of VaR measures undermines the stability of markets.
It’s the type of risk management practice that works well as long as it is not needed; just like Bernanke observed after the credit crisis about their standard models that proved to be “successful for non-crisis periods”.
-Harold de Boer Transtrend
Opalesque Roundtable series ’17 Netherlands
Look for Firms with a Risk Advantage Not Just Risk Management – The Case within Money Management
There has always been a lot of talk about the competitive advantage of a firm. For money managers, it has been about their edge. However, there is a new focus by some consulting forms about a firm’s risk advantage. (See BCG’s Henderson Institute – “Taking Advantage of Risk” and the BCG’s Perspectives piece “From Risk Take to Risk Manager”). This strategy work has focused on a firm’s “risk advantage” as an alternative to competitive advantage. Firms that manage their strategic risk options can add value relative to those that look at risk management as a police function.
Navigating Risk: Lessons from the US Navy for Money Managers
The US Navy has an structured approach to risk management which is slightly different than the Marine Corps and US Army. See our posts on US Marine Corps and US Army risk management. The US Navy actually has a trifold brochure for Time Critical Risk Management. Would you ever expect to see this from a money manager? Certainly, the ABCD process is a loop for determining any trade or portfolio action.
Risk Management the US Marine Corp Way – It Is a Process
If you have to ask most people what is one of the riskiest professions, it is likely being a soldier. The downside is huge, death. The uncertainty of any battle situation is extremely high. No amount of planning can truly address the uncertainty and dynamic situations associated with battlefield situations. This uncertainty and risk is why training and risk management are so critical for armed forces.
Exits as Important as Entry Points? A Critical Issue
“I made my fortune by selling too early”, a quote from Baron Rothschild used for an investment game by John Hussman. John Hussman has invented a game called “Baron Rothschild” as a teaching tool which is based on a simple process of drawing returns from a set of cards The sequence of cards can generate a performance record. Think of this as a form of Monet Carlo simulation from a return distribution. The player can call stop after any number of picks or he can continue to pull return cards to compound his performance.
What are the Best Investment Warnings?
So what is a warning? A warning is defined as a statement or event that may indicate a danger, problem, or an unpleasant event. With hindsight, we can always find warning signs, but the real question is whether you can see warnings before the fact. The warning has to strong enough to change current thinking. For investments, a warning could be information that contradicts a given narrative. The narrative is the story that generates a specific trade or allocation.
Risk Hurdles
Risk management is more than applying quantitative tools to measure things like volatility or skew. It is an operational management problem of gathering and reporting data. The quality of risk management is related to the ability of a manager to properly aggregate data for analysis. Hence, strategies that have greater operational problems at gathering information on risk will have higher risk.
Surprises Happen – Black Swan, No
Tail events will often lead to over-reaction as seen in the market action overnight. The worth of a manager is not measured by his ability to build and adjust portfolios in calm times but his ability to navigate and manage through uncertainty.
Navigating uncertainty is not always taking action but at times learning to do nothing. Discussion with managers suggests that some systematic managers did not take model signals last night. Markets moves out of proportion to the discounted futures cash flows signaled that no action was best.
Managing uncertainty starts with core portfolio construction. Extra diversification is necessary when there is extra risk. Diversification may come through differences in timeframe and styles when correlations across asset classes have the likelihood of moving to one. Managers are paid to build portfolios, manage risk, and take action on changes in economic fundamentals, this cannot generally be done with passive investing.