COMMENTAR Y


New Frontiers of Risk Revisiting the 360° risk manager Extracts from a report by BNY Mellon and HedgeMark International LLC


In collaboration with Nobel Prize-winning economist, Dr Harry Markowitz, BNY Mellon’s Investment Services and Investment Management groups have combined resources with HedgeMark International, LLC to provide an inside look into the institutional investment risk management field.


For the institutional investor


Risk management is a puzzling proposition for institutional investors. Just as we develop meaningful controls to manage the underlying risks associated with the last market crisis, new risks keep emerging and old ones keep evolving. To help you better understand and manage the ever-changing nature of risk, I am pleased to present the latest in BNY Mellon’s thinking, New Frontiers of Risk: Revisiting the 360° Risk Manager.


This white paper provides an inside view into the formidable risk pressures that institutional investors are up against. From new regulations, to transparency concerns, to investment risks across the board, we look into the attitudes and actions of institutional investors to find what has worked for them and what hasn’t. To that end, we surveyed over 100 institutional investors, including pension funds, endowments and foundations, with approximately $1 trillion in aggregate assets under management. What they told us has led to some surprising findings, especially when it comes to generating alpha, as shown in the pages and charts that follow.


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At the start of this study, we turned once again to the expertise of Dr Harry Markowitz, the pioneer of Modern Portfolio Theory (MPT), 1990 Nobel Prize-winner in economics, and long-time friend of BNY Mellon. Dr Markowitz collaborated with us on our first risk white paper in 2005, New Frontiers of Risk: The 360° Risk Manager. Back then, the need for more structured and holistic risk management was just beginning to be recognised. Now, almost a decade later and in the wake of the 2008 financial crisis, risk management is a foremost priority of just about every institutional investor.


n our previous white paper, which also included valuable input by Dr Markowitz, we found that pension funds and non-profits were just starting


to take a more serious look at risk management. Now, some eight years later and post the 2008 financial crisis, our 2013 survey shows that risk management is more critical than ever. Among our major findings:


The 2008 financial crisis – a new awakening of risk awareness: the 2008 financial crisis caught many institutional investors off guard. The risk management procedures then in place were widely perceived to be insufficient for a crisis of such magnitude. The drive for more effective, holistic risk management was soon on.


Increased use of alternatives: survey respondents have expanded their use of alternative investments to improve diversification and potentially help with downside risk. Institutional investors plan to increase their allocations to alternatives over the next five years.


No more chasing alpha: it’s down with alpha and up with targeted returns. Institutional investors are placing greater emphasis on achieving absolute return targets as opposed to outperforming a market benchmark. Risk budgets, matching liabilities and avoiding downside risk all play an important role in this shift.


Analytical tools on the front lines of risk management: analytical tools based upon risk/ return analysis and performance attribution


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I would like to extend my personal thanks to all of our clients and prospects who participated in this survey. And to Dr Markowitz, whose contributions in the field of risk management are as relevant and valuable as ever, we are proud to work with such an esteemed luminary. Together, we are advancing our way through the new frontiers of risk.


Debra Baker


Head of Global Risk Solutions BNY Mellon Asset Servicing


continue to be the most commonly used to model, analyse and monitor investments. Total plan/ enterprise risk reporting tools are on the rise to encompass traditional and alternative investments, as well as liabilities.


Avoidance of unintended bets: a desire to avoid unintended leverage and to better understand underlying investments has grown markedly since the 2008 financial crisis and appears to be driving institutional investors toward solutions offering greater investment transparency.


Foreword by Harry Markowitz, Ph.D


A long time ago in a galaxy far, far away – or at least it seems that way as compared to the risk control procedures now practiced by institutional investors, as reported herein based on BNY Mellon’s risk practices surveys of 2005 and 2013. Actually, it was sometime in 1950 while reading John Burr Williams's Theory of Investment Value (Williams,


1938, 1989, 1997) in the library of the University of Chicago’s GSBA (now called the Booth School in honour of a benefactor who made his fortune in what might be called the MPT industry) that it struck me that the financial theory of the day did not adequately account for portfolio risk. I am of course delighted to see from the two surveys that MPT continues to be used as a major tool in portfolio management, and that the ideas that came to me almost exactly in the middle of the last century are still referred to as Modern Portfolio Theory. Multiplying the percentages reported in the surveys times the size of the institutional investment management industry – let’s say it is up to $30 trillion – suggests that tens of trillions of institutional AUM (assets under management) are managed with the aid of MPT.


I will not try to summarise the results of the two surveys. The paper does an excellent job of that. Rather I will share with you some thoughts about the lessons learned since our 2005 white paper, and express some concerns about where we are heading.


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