Secrets of investment risk management: how the risk management system works

one of the most important criteria for evaluating the performance of management companies is the existence of an effective risk management system. Investments are connected with risks. This is an axiom. Take any kind of business: if you don’t know the rules of the game, you most likely won’t be able to succeed. No one is going to fly an airplane unless they know how to behave in emergencies. It’s the same in finance.

One must be able to do more than just select assets by yield, predict the behavior of markets, possess the skills of fundamental analysis and a bunch of useful skills. To achieve the highest results in investments one must timely identify risks of different nature, manage these risks, reduce their impact on the outcome to a minimum. To do this, every investment management company that respects itself and its clients has a special “fighting” division of risk managers.

In the boisterous and merry years when investment trust management was just emerging in Russia, companies had no risk management as a separate business segment. Nobody saw a reason to have a separate full-time risk manager. By default, it was believed that the portfolio manager was responsible both for return on investment and for any drawdown. After all, it is also a kind of profitability, only with a minus sign.

In some companies, to put it mildly, such practice is still in force. The banking sector was a pioneer in risk management. Banking regulation in our country is more developed because it has taken a longer time to develop. This experience has shown that an alternative weighted opinion is very useful in decision-making. There were developed norms of regulations, allowing to estimate borrowers on a systematic basis rather than at will. Financial institutions learned how to assess and manage

  • credit risks in their interactions with partners and counterparties;
  • market risks arising from changes in market conditions;
  • liquidity risks, so that all types of transactions are backed by cash;
  • operational risks associated with the company’s operations;
  • legal and reputational risks.

Management company “Sistema Capital” adheres to a clear principle: risks must be handled by professionals, each action of the company, each proposal to clients must be considered from different sides, and the final decision is taken collectively.

What does an investment risk specialist do?

Concerning an investment idea (in which assets to invest the money of unit investment funds’ investors, in what amounts and for how long), the risk manager acts as a “bad cop. His task is not to cut the manager’s cool project off at the root, not to pass judgment on whether the idea is good or bad. He describes its potential in terms of risks, pluses and minuses, and determines what the client will get in the output of a positive or negative scenario.

The arguments of the portfolio manager and the risk manager, along with the evidence base, are presented to the panel. The decision to buy or sell certain assets is made by joint voting.

There is a certain battle between the portfolio manager and the risk manager. It is clear that the manager is interested in his idea: while he prepared and nurtured it, he got used to it, it became very close to him. Even if, as a result of thinking about it, he found some risk in it, he is likely, purely psychologically, to lower its weight. That’s a normal story. I, on the other hand, come at this idea initially from the risk side. As a result, the investment idea may not be as bright and attractive, but it is certainly more real and alive.

Figuratively speaking, the portfolio manager develops the recipe for the investment “dish”, selects the ingredients, and the risk manager checks it all for compliance with the flow chart and adds some spices. A risk manager’s job involves, in general terms, three main sets of tasks:

  1. Identification of risks, identification of bottlenecks, which may in the future be detrimental in some way. And it is not only about investment proposals: he monitors the company’s business processes, compliance with the requirements of internal documents and so on.
  2. Correct description of risks and assessment of consequences. The risk manager’s arguments should be presented in a form that his colleagues can understand, in the language of numbers.
  3. Selection of the optimal risk management strategy. Some events will have to be eliminated by changing business processes (for example, refusing certain types of investments that do not meet the requirements). Other events will have to be limited by setting risk limit points for them. It is important to monitor and control all of these processes and make sure that they do not go beyond the limits set for them.

What investment risks are there

Within the framework of trust management of investments, we deal with the following categories of risks:

  • managing company risks;
  • client risks.

Both of these blocks are closely interrelated. All possible problems, from the client’s point of view, are still associated with management mistakes. No one thinks that maybe he or she made a miscalculation when choosing a managing company or an instrument for investing funds. Such an investor simply won’t come back with his money next time.

Internal risks in a company are operational risks related to proper business processes and strategic risks related to the choice of strategy (say, one can miss a market segment).
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Credit risks are realized by investing in MC’s own funds. Like banks, management companies have capital requirements. We try to invest these funds in conservative and safe instruments.

Besides, MC regularly submits a great number of various reports to clients and regulators. It is necessary to make sure they are issued on time and in full, as required by the law.

Client risks in general outline repeat the risks of investing own funds of the company, the main focus of asset management is on them. The main risks here are associated with changes in market quotations, which negatively affect the total value of the portfolio.

Liquidity risk should be singled out in this category, where there is a risk that a client will not close position on certain securities in due time when he is about to withdraw a large amount of money.



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