Views from the Dark Side Bill Martin - Global Head of Investment Risk GARP/ISDA Risk Forum 19...

Views from the Dark Side Bill Martin - Global Head of Investment RiskGARP/ISDA Risk Forum19 December 2001

2INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

The Dark Side refers to the “Buy” side

– Investment Management

– Asset Management

– Fund Management

Why “the Dark Side”?

– ”Accept the power of the Dark Side”• Darth Vader to Luke Skywalker – Star Wars

IV

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Views from the Dark Side

Traditionally, the leaders of “risk management” have come from the “Sell” Side of

investment banks– Mark-to-Market

followed by commercial banks,– Traditional credit expertise

followed by consultants,

advisors,

academics,

rocket scientists,

IT propeller heads,

We created an Industry!

4INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

What would one expect from a “Sell Side” risk manager:

– Specialist expertise by risk discipline:• Market Risk

• Credit Risk

• Operational Risk

• (maybe) Portfolio Management

• Regulatory Issues/Basle II

5INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

What would one expect from a “Sell Side” risk manager:

– Specialist expertise by asset class:• Fixed Income

• Equities

• Credit Risk (structuring, pricing, documentation, recoveries)

• Credit Trading

• Derivatives/Exotic Derivatives

• Currencies/Commodities

• Emerging Markets

6INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

In moving to the Sell Side:

Is this appropriate? Is it sustainable?

Are the skills transferable? Are they sufficient?

Is the knowledge transferable?

What’s the big deal?

7INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

The big deal?

O

P

M

8INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

The big deal?:

Other

People’s

Money

9INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

What do they want?:

– Performance

• Absolute

• Relative

10INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Management - the challenge:

– To deliver superior investment performance in a manner that is consistent with the mandate and/or expectations of our clients.

11INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Risk - the challenge:

– To design and implement an approach to investment risk management that adds value to the global investment management process

12INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Global Investment Management Process:

Macro research & asset

allocation

Micro research & stock/security

selection

Portfolio Construction

Risk Management

Performance Monitoring

13INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Risk – how would you define it:

– As an investor:

• Investment Risk: the failure to deliver investment performance that is consistent with the mandate and/or expectations of our clients.

• Unpleasant surprises

14INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Risk – how would you define it:

– As a risk manager:

• Investment Risk: the measurement and assessment of exposure held by Invesco Global and its clients’ portfolios to expected and unexpected volatility in financial performance and the requirement to ensure that exposure to unexpected volatility is managed effectively and comprehensively at product level.

15INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Risk – What are the Strategic Objectives?:

– Play an active, integral role in the firm’s global investment management process.

16INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Global Investment Management Process:

Macro research & asset

allocation

Micro research & stock/security

selection

Portfolio Construction

Risk Management

Performance Monitoring

Buy List – Credit Risk Assessment

Volatility Analysis

“What if…”

17INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Risk – What are the Strategic Objectives?:

– Embed a strong, consistent risk culture within the firm’s global investment management process.

• Risk Culture relates to the behavior

– the proactive management of risk vs. reward.

• As we work to deliver superior investment performance, actions must be consistent with any client’s mandate and/or their needs.

18INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Risk – What are the Strategic Objectives?:

– Define clearly and precisely the design and structure, roles and responsibilities, priorities and deliverables of Global Investment Risk.

19INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Risk – What are the Strategic Objectives?:

– Play an active role in the growth of the firm through participating in:

• investment performance communications,

• client presentations,

• new product development.

20INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Risk – What is the end game?

– To minimize the firm’s exposure to:

      Unexpected volatility of investment performance relative to

mandate

      Persistence in investment underperformance

      Loss of client assets/Loss of growth in client assets

      Loss of revenue/Loss of growth in revenues

      Loss of capital

21INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Do we design by risk type?:

– Specialist expertise by risk discipline:• Market Risk

• Credit Risk

• Operational Risk

• (maybe) Portfolio Management

• Regulatory Issues/Basle II

22INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Do we design by specialisation?:

– Specialist expertise by asset class:• Fixed Income

• Equities

• Credit Risk (structuring, pricing, documentation, recoveries)

• Credit Trading

• Derivatives/Exotic Derivatives

• Currencies/Commodities

• Emerging Markets

23INVESCO Asset Management Limited - Regulated by IMRO

Portfolio Construction

Views from the Dark Side

The design:

Investment Risk Policy (Minimum Standards)

Contribution Attribution and Performance Assessment

Product & Style Integrity Assessment

Risk-adjusted Portfolio Analysis (Volatility Analysis; “What if” analysis)

Core Competencies

Drive the Investment Risk Management process to the performance generating level of the organization across all products, including funds managed directly as well as those managed on an advisory basis.

ExceptionReporting

Local RMC

GRMCGlobal Risk-Adjusted Performance Analysis (GRaPA)

Investment Risk Managers

GMAC

24INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Contribution, Attribution and Performance Analysis

– Contribution – • What factors contributed positively to absolute performance?

• What factors contributed negatively to absolute performance?

– Attribution – • What factors had a positive influence on relative

performance?

• What factors had a negative influence on relative performance?

– Performance –

• Ranking of Performance:

– Quartile

– Time

25INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Product & Style Integrity Analysis

– Marketing Proposition is “Multi-Product/Multi-Style”

• What is defined in the Mandate or Product Specification?

• Are we operating within the mandate?

• No “wiggle room”!

26INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Risk-adjusted Portfolio Analysis– Practical Application of Risk Specialisation

• Market Risk

– Value @ Risk / Assets @ Risk / Performance @ Risk

– Stress & Scenario Testing

– Simulation

» “What would be the impact on performance?”

• Credit Risk

– Expected Loss

» Loss Given Default

– Unexpected Loss

27INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Risk-adjusted Portfolio Analysis (continued)

– Practical Application of Risk Specialisation

• Volatility Analysis

– Expected Volatility

– Unexpected Volatility

28INVESCO Asset Management Limited - Regulated by IMRO

Probability distribution of P&L'sP

rob

abil

ity

Monthly Performance (%)

+- 0

5% chance of unexpected loss

-1.5%

5% chance of unexpected gain

+3.0%

INVESCO Asset Management Limited - Regulated by IMRO

Risk-Return

-5%

5%15

%25

%35

%45

%

0% 20% 40% 60% 80% 100% 120% 140%

Risk (% Equity)

Mea

n R

etur

n (%

Equ

ity)

30INVESCO Asset Management Limited - Regulated by IMRO

Risk Appetite and Unexpected Volatility

-50%-45%-40%-35%-30%-25%-20%-15%-10%-5%0%5%

10%15%20%25%30%35%40%45%50%55%60%

Risk (% Equity)

Mea

n R

etur

n (%

Equ

ity)

31INVESCO Asset Management Limited - Regulated by IMRO

Risk Adjusted Performance Measurement

ELEL 99 %99 %

BaseBase

Pro

bab

ilit

y D

ensi

tyP

rob

abil

ity

Den

sity

Loss Loss £m £m

Base CaseBase Case

32INVESCO Asset Management Limited - Regulated by IMRO

EELL

99 %99 %

BaseBase

New New ProfileProfile

Pro

bab

ilit

y D

ensi

tyP

rob

abil

ity

Den

sity

Loss Loss £m £m

Risk Adjusted Performance Measurement

Adjusted ProfileAdjusted Profile

33INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Risk - the challenge:

– To design and implement an approach to investment risk management that adds value to the global investment management process

34INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

Investment Management - the challenge:

– To deliver superior investment performance in a manner that is consistent with the mandate and/or expectations of our clients.

35INVESCO Asset Management Limited - Regulated by IMRO

Views from the Dark Side

At Invesco:

“All we do is invest”

Views from the Dark Side Bill Martin - Global Head of Investment RiskGARP Risk Forum19 December 2001