Risk management is still a new concept in the alternative
investment community, particularly in Japan. Unfortunately,
there is no textbook definition of risk management just like
there is no textbook definition of corporate management or
fund management; which further complicates how risk management
is implemented. These terms merely reflect the culture and
philosophy of the management team, which uses its skills running
a business. Risk management therefore reflects the culture
of the company or fund that the management team has already
An MBA should equip an individual to manage a company just
as a CFA equips a CIO to manage money. These academic and
technical skills are sometimes viewed as pre-requisites for
business and fund managers but they certainly do not guarantee
satisfactory results. Likewise in risk management, there are
now certifications for risk managers in the sell-side industry.
But obtaining such a degree does not make a risk manager.
The most important criterion for a risk manager is the ability
to utilise his technical skills in order to serve the management
team in accordance with the team's culture and philosophy.
From my career in risk management, I have identified the
following main responsibilities of a risk manager:
- To be a "value-adding" resource for the management
- To increase the efficiency of the risk/return ratio for
- To be the guardian of capital preservation.
- To be the credible source of information on global risk.
The first responsibility clarifies the confusion between
the management team and risk management. I have often been
told that the management team does not need a risk manager
because the managers do an excellent job controlling the downside
volatility of their product. A lot of talented people can
certainly provide an excellent risk management job. However,
most of the fund manager's time is consumed by investment
decisions and marketing and as a result, he or she does not
have the spare time to follow tedious and complicated risk
Someone who has experience in risk management should analyse
and provide summary information on the fund's risk levels
so the manager can more efficiently allocate time to investment
activities. The risk manager's job is not to manage the portfolio's
value, but to provide the current status of the portfolio
given the historical and the predictable future courses of
market moves. This could result in a useful model to stress-test
the portfolio for future market moves, which would help the
investment manager's decision-making process.
The second responsibility is closely linked to the first
one, but applies more to complicated organisations. Instead
of a single strategy fund, let's assume products with multi-strategies,
funds of funds or diversified investment portfolios. In each
strategy or at each sub-portfolio level, the responsible fund
manager is managing multiple price risks and potential portfolio
At the individual investment level, risk control and optimisation
of the risk frontier can be analysed and pursued. But this
may not be the case at the aggregate portfolio level. This
is a common challenge for large funds with multiple strategies
and institutional investors with diversified investment portfolios.
It is hard to rank investment products by quantitative methods.
Even if you are happy to use statistics to rank funds, the
best performing product may not be the best choice for your
portfolio since portfolio balance and the effect of newly
added funds matter a lot. So you need to consistently test
your portfolio against dynamic market moves and how the selection
of new investment products affects your portfolio's overall
The third responsibility deals with a different time scale
and mind set. For day-to-day investment activities, certain
risk scenarios need to be scaled down. For example, what is
the chance of North Korea launching a missile at Tokyo? If
you are worried about this scenario today and spend all of
your money on Nikkei puts, you probably have some information
that most of us do not. Instead, most people put a certain
probability on a scenario and scale the result accordingly.
In risk management jargon, we call this Value at Risk (VaR).
This is a very useful technique to aggregate the risks of
different asset classes and even risk categories.
However, no matter which methodology of VaR calculation is
used, it is only a scenario testing; and the scenario here
assumes ordinary market moves. In order to complement this,
many people may scale up the confidence level, extend the
sample data or use stress-testing, which assumes extraordinary
Risk-taking activities are necessary in any business and
some kind of quantification does help to make decisions. However,
knowing the existence of risk against a certain scenario is
more important than trying to improve the accuracy of its
quantification. It is not the question of whether the stress-testing
results are accurate or not, but whether the stress scenarios
are useful in managing the portfolio. Such qualitative risk
management over quantitative one should prevent unwanted risk-taking.
Finally, one of the most active risk management discussions
in hedge funds in recent years concerns portfolio risk disclosure.
At publicly traded companies, the chief financial officers
are responsible for disclosing credible financial data to
the investment community. Many financial institutions have
also created the role of chief risk officer - responsible
for disclosing risk data to investors and regulators when
For investment management firms, being able to provide credible
risk data to investors could prove the firm's risk management
capabilities and possibly save the fund from unwanted redemptions.
Therefore, it is necessary to have an efficient risk management
infrastructure including risk systems, which produce metrics
that are easily promulgated to interested investors. By setting
up such risk management infrastructure, challenges of the
above-defined risk management can be satisfied by professional
risk managers. The alternative investment community will not
be satisfied with "Mickey Mouse" risk management
reports created for regulated banks for compliance purposes.
They demand it to be innovative and value-adding in accordance
with their fund and investment cultures. This should be the
way to go for risk management.
* Yoichi Umeki is a director of Asia-Pacific
Consulting in Tokyo and represents SunGard's Reech products
and services in Asia. He has been an active steering committee
member of Tokyo Risk Managers Association and regularly participates
in AIMA Japan activities.