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What a Sadist Taught Me About Risk Management

by trusted insight posted 3years ago 9719 views
Post by: Greg Silberman, the Chief Investment Officer of Atlanta Capital Group. Atlanta Capital Group specializes in creating custom private market solutions for RIA/Family Office clients and is an active acquirer of independent wealth management practices.
 


“Every day of high school we were preparing for War”
Sandringham High School
That’s the name of my high school – in Johannesburg South Africa.
Sounds posh doesn’t it?
Named after the 20,000 acre estate near the village of Sandringham in Norfolk, England.  Queen Victoria purchased the land in 1862 at the request of the Prince of Wales (the future Edward VII) as a home for himself and his new bride, Princess Alexandra.
I attended High School in the mid to late 80s.
Consider that Nelson Mandela was freed from 27 years imprisonment on February 11th 1990 and inaugurated as the first Black President in 1994.
That means that the mid to late 80s was essentially the height of the ‘struggle’. The apartheid regime was doing everything it could to maintain its grip on power. The power that they believed was ordained upon them by none other than the Lord Himself – if interested, read the brilliant tomb by James Michener called The Covenant for more insight into the Afrikaaner (White immigrants to South Africa of Dutch Huguenot origin).
Every day of high school seemed like we were preparing for War!
Against whom nobody really explained to me.
Police would come to our school and show us what hand grenades and AK47 assault rifles and bags of marijuana looked like. Why? I guess in case we came upon an arms stash or needed to score some high quality weed?
In all fairness bombs were going off everywhere – shopping centers and Rugby games.
Clearly we were under attack but it was difficult to identify who our attackers were and even who ‘we’ were. That’s what effective propaganda does. It confuses Infinitely.
side note: many years later we found out that the Apartheid government was arming Inkatha – the Zulu nation – in what became known as the 3rd force to disrupt the ANC – Nelson Mandela’s party – from ascending to power.
So, on the grounds of a High School named after a distant Royal palace and under siege from a fearful foe who may have been tending our lawns, I obtained my high school education … and to think, all I was interested in was chasing girls!
Given this backdrop our teaching faculty contained some real nut jobs!
Sadists & Racists that benefitted from what I would describe as ‘reverse’ affirmative action. Not all the staff mind you, there were some amazing educators among them for sure.
In particular I remember (not so) fondly my Industrial Arts teacher [who will remain nameless]. I believe the equivalent in the States would be Wood Shop. This cheerful little man would stand outside the workshop as we filed past him one at a time with a cricket bat in hand. Once the bell rang if you were not already in class i.e. You were still filing in, you were effectively late. Which OBVIOUSLY meant you deserved a backside warming … in fact that was the beginning of a wonderful 45 minutes of blind fear and arbitrary beatings. This took place on a near daily basis.
Now there is something to be said about associating learning thru pain … it causes you to learn QUICK and to avoid doing the things that cause the pain.
Unfortunately I was hopeless at wood work – which is ironic because I come from a long line of brilliant furniture makers – but this certain skill past me by. Which meant I spent more time re-cutting, re-drilling and repairing. BUT I did learn one thing and that was to measure, measure and measure some more before making an irreversible slice.

What’s a Geyser?

I speak English … sort of
The most humbling experience an immigrant will experience in the New World is a trip to Home Depot. Why is it you can never get out of that store without dropping $100? It’s a good business they’ve got it figured out.
I don’t remember exactly when this happened so for impact let’s assume I was fresh off the boat. That’s about right.
I’m renting an apartment on Peachtree Dunwoody Road in Atlanta Georgia.
I’m getting my family set up and need some stuff at “The Depot”.
In I go:
“Hello Sir, how can I help you?”
“Ummm ja, I need the following items pleez [that’s what a South African accent sounds like in writing]:
1 – Globes
2 – Nails to fix a wire to the skirting board
3 – Oh and how do I increase the water temp in my Geyser?
The guy looks at me with that blank stare I’ve now grown accustomed too.
At this point he is definitely thinking to himself – so this is why the call them Aliens.
After about 10 minutes of drawing diagrams in the air and playing charades he finally figures out what this idiot is asking him for:
1 – Light bulbs
2 – Nails to run a wire along the crown molding
3 – How to light a fire under the old guy back in the apartment ☺ OK OK how to turn up the temperature on the hot water heater.
And I thought I spoke the Queen’s English.
Ultimately the lesson here, beside knowing what the heck you are asking for, was measure the light wattage, the length of the wire and the desired temperature of the hot water (Fahrenheit not Celsius) before embarking on a quest to La Depot.
So how does this relate to investing?
As investments becomes ever more complicated, as family offices and HNW individuals assemble portfolios of greater complexity and varied investment vehicles THERE IS A NEED TO MEASURE RISK AND MEASURE some more.
Structured products, locked-up private investments and fund of funds of funds create the need to understand these portfolios multi-dimensionally:
  • Liquidity;
  • Leverage;
  • Underlying or look-through exposures;
  • Convexity of returns
The liquidity aspect was particularly acute post 2008, as many institutions found out, when private equity distributions all but dried up yet capital commitments still had to be funded … creating quite a robust secondary market.

I have tried many different risk management systems but noticed a) they weren’t equipped to deal with advanced analytics that alts require or b) had difficulty with esoteric cash flows, leverage etc. or c) were too expensive. 

A non-profit group called Open Protocol, comprised of large alternative investment managers and institutional investors, attempted to codify and standardize terms across different instruments and strategies. The result is called OPERA or Open Protocol Enabling Risk Aggregation, with the result that risk can be AGGREGATED and COMPARED across a diverse portfolio of assets.

They were kind enough to publish their risk schema and comprehensive explanations for anyone to download for FREE. If you want to understand the constituents of portfolio risk better or want to be more fluent in risk management it’s a great resource.
 
http://www.theopenprotocol.org/top/
Data Aggregation, Risk Management and Reporting
If you want to cut to the chase then here it is – my list of top aggregators, risk management and report providers:
  1. Novus – is an institutional quality aggregator. Found by ex-fund of fund guys. They will import ALL your underlying manager holdings on a monthly basis regardless of source (managed accounts, paper risk reports, public filings etc.)

    You will then be able to interrogate your portfolio from any conceivable direction. Drill down by geography, instrument, sector, rating, risk factors etc. etc.

    What is particularly useful is the stress testing and sensitivity analysis because it incorporates imbedded options and can thus help you create the all-important portfolio convexity.
     
  2. Hedgemark is an affiliate of BNY Mellon which means they have a look-in to $ Trillions of managed account assets under custody. Hence their analytics can provide t+1 position level transparency plus monthly reporting for other funds.

    A Global multi-asset class holdings based risk system. What’s good about Hedgemark is their valuation models particularly their capabilities in pricing OTC derivatives.

    Pro: Both Hedgemark and Novus have attractive easy to use and navigate systems with mobile functionality.

Pro: What if analysis on both systems is very powerful

Pro: I have seen a large fund of fund manager use the Novus risk reporting tool to effectively monitor thematic and overlay trades.

Pro: the multi-dimensional reporting caters for leverage and liquidity – arguably the 2 most important risk characteristics when incorporating alternatives such as private equity or global macro.

Pro: Both these systems are popular with investment managers because they effectively isolate individual team member’s attribution AND allow managers to monitor compliance with written investment guidelines.

Con: Institutional level risk management systems come at a price and may be above most non-institutional users’ budgets.
 
  1. Albourne – Admittedly it’s been a while since I was a user here … they do a lot right and there research is in-depth and terrific. What I appreciated most was their back office operational due diligence reporting.

    Let’s face it back office is boring  BUT Investment Committees that oversee multi-manager portfolio need to understand their exposure to:
 
    1. Counterparties;
    2. Prime Brokers;
    3. Administrators;
    4. Auditors et al.
       
  1. I didn’t quite know where to put this one so it will go here: Convex Capital Management

    If ever there was a firm whose foundation was Measure Twice Cut Once this is it!

    Incredibly data hungry their “adaptive approach to dynamic risk management” recognizes that market regimes shift and that the greatest source of returns may be achieved by correctly identifying the current regime. This is done thru measuring:
 
  1. Fundamentals – GDP, inflation, LEI etc.
  2. Yield Curve analysis
  3. Quant analysis – Markov regime-switching
  4. Volatility clustering

Enter Clearserve – a VC backed start-up that provides consolidated reporting primarily for Ultra High Net Worth, Private Bank and Family Office clients.

Multi-asset class aggregation and reporting has traditionally been handled through cumbersome Excel and “clunky” legacy portfolio management software.

Clearserve has an elegant Cloud-based SaaS solution. I particularly like the alerts dashboard that reminds you when redemption requests should be placed to ensure integrity of portfolio liquidity.
 
BONUS 6: You’ve stuck with me this long so here’s my way of saying Thanks.
My BONUS idea. Actually I have to give my colleague Evan Carter kudos for this one.
As portfolio managers we go to great pains to segregate assets and accounts based on risk and return goals.
Whether it’s our own personal capital or a multi-billion $ Endowment fund we normally end up with far too many accounts and vehicles.
Evan’s idea is to use technology to superimpose your goals ON TOP of your overall pool of capital. Think of it as a lens that artificially delineates and segregates capital based on assigned risk and return goals [or other goals such as liquidity].  
If you think about it it really creates a powerful model in which you could seemingly access investment choices based on going after Alpha despite it being contrary to your ultimate goal for that capital pool.
Gonna have to think about that one a bit more Evan!
I hope you enjoyed my tour of risk management land and learned something. I think at 1,900+ Words its time to HIT publish on this one – it’s a wrap.
Warm Regards,
Greg
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Thank you for reading my post. I regularly write about private market opportunities and trends. If you would like to read my regular posts feel free to also connect on Linkedin, Twitter or via Atlanta Capital Group.
Greg Silberman is the Chief Investment Officer of Atlanta Capital Group. Atlanta Capital Group specializes in creating custom private market solutions for RIA/Family Office clients and is an active acquirer of independent wealth management practices.
Advisory Services offered through Atlanta Capital Group.
Main photo: source Eneas