Riskmanagement
We’re still digesting the MF Global collapse, and we’re guessing it will be the case study for the intersection of risk management and culture/ incentive systems – not that it could ever be separated, but this was the case that really drove it home because of the inconceivable use of client funds… We highlight several articles on counterparty risk, fraud and MF Global inside.
It would be easy to dismiss anything coming from Citigroup, not exactly the bastion of sound risk management practices. And it does appear like Vikram Pandit’s main suggestion here is, at first glance, simplistic yet hard to implement. Anyway, moves in the right direction are welcome, but on risk management issues, we tend to defer to Taleb (new talk inside).
Just as in our September 2011 post called “How to spot a fraud”, a Wall Street Journal piece tells another story about returns that look too good to be true – but in this case, “too good” means “low volatility”. The point here is the ages-old trap of equating “risk” with “volatility” and assuming that a low-volatility fund is less risky. Even ignoring the possibility of fraud, it’s a bad move.
We were initially skeptical because, as Buysiders.com readers are probably well aware by now, we view risk management as a matter of knowledge gathering/sharing and corporate culture. The excerpts inside this post explain our satisfaction with the video. It’s not enough for us to judge whether this course is a great investment for you or your company, but we have attended classes with Bob Kaplan (and other) at Harvard and we certainly got more than our money’s worth.
We continue to learn from the collapse of Jon Corzine’s MF Global. A recent article at NYT’s Dealbook highlights another lesson: ignore your chief risk or compliance officer at your own peril. While we agree that in this case it might have led to different and better decisions, such officers are still prone to all the talent, behavioral and incentives-driven traps and pitfalls. That said, the simple governance, hierarchical and process improvements the author suggests do help, and he also has the merit of recognizing that “Leadership has the right to challenge, disagree or even reject that advice.” Remember: “Culture eats Strategy for breakfast”.
The IMF has recently issued a report on China’s financial system’s stability that has grabbed plenty of headlines, and yet today it seemed that there were pessimistic articles about banking all over the world. European and US banks are also the subject of stories that highlight risk, interconnectedness, poor balance sheets etc.. While the financials’ situation isn’t necessarily news, it is the trend that’s interesting. Inside we collect quite a few articles about the world’s financial system, all of them very from yesterday or today. Collectively they plant a bleak picture, one that seems very different from what we (still) observe in Brazil’s banking system. It’s very hard to separate signal from noise, especially so in the middle of a crisis, but it’s great food for thought.
Three recent stories with one theme in common: the rise of the middle class and the availability of credit. Looking at banks or diversified financials top-down is not our specialty and, as we’ve said in our Q3 2011 report, “is only of interest to us in order to gauge an important part of the risks”. Keeping this in mind, one of the articles is bullish and points to recent reports showing that credit here has actually accelerated in September, despite talks of banks – and financial authorities – reining in loan growth. The other two articles are also bullish but still reflect, in a way, the difficulties of sustaining such growth.
We’ve been arguing that “to finish first, first you must finish” for over twenty years. We’ve also recently argued for cash as a strategic weapon with both defensive and offensive features: it is as much “cushion” as it is “cannon”. Nicholas Nassim Taleb has given a lecture recently and the main takeaway is this: “(…) you live long by not dying, you win in chess by not losing—by letting the other person lose. So negative investment is not a sissy strategy. It is an active one.” He also highlighted the planning fallacy, something David Brooks wrote about even more recently, so we’re taking the opportunity to post both together.
Many dimensions to this Op-Ed by Robert Shiller about “the surge in stock market volatility” in August. A few days later, another article argued that “market swings are becoming new standard”. The first question to ask is whether the short-term reality of higher volatility isn’t simply being taken for granted and extrapolated into the future, but the second runs deeper: would it really be so bad for long-term value investors?
We thought we had stumbled upon an older article when we saw this piece in the Financial Times a few days ago: “Get used to world without a risk-free rate”. We had published a Financial Times video pretty much on the same subject and using the same arguments – but yes, it’s a new article altogether. Given the timeless importance of the subject, let this be an excuse to bring it back to our attention.
