Financial crises are lame. But they do serve as reminders that risk-taking is, well, risky. Yes, your Dh10m house can lose half its value. And yes, so can your stock portfolio. But risk also has many dimensions that go beyond the mere markets, as we've also been reminded of late (hello Lehman Brothers). Here's Patrick Trew, chief risk manager at CQS, giving his take on risk today at the UAE Global Investment Forum in Abu Dhabi. Good stuff:
Much intended risk in a portfolio is clearly market risk and is well
understood. Not always well-explored, but [it is] certainly well understood
what the drivers of risk are in terms of movements in spreads, rates,
curves etcetera. But ultimately I think what the events of the past
year have driven home in many people's minds is that many other forms
of risks may exist in portfolios. If you look for example to the
significant political and regulatory risks that exist covering almost
all asset classes at the moment, you have many actions by national
and supernational bodies seeking to mitigate risk but leading to
unintended consequences. Think for example of the impact on the
potential hedging of a portfolio that resulted when regulators in many
different jurisdictions imposed short selling restrictions. Ultimately
they had the best intentions in mitigating aggressive speculative
selling, but of course you weaken price discovery and you weaken the
ability of hedges to manage the risk in their portfolios. So there are
challenges with events like that. Many other events, in terms of the
government resuce packages in certain countries, have not precipitated
exactly the mitigations they were seeking to achieve. If you look to
other forms of risk well beyond market risk, there are risks associated
with counterparties failing, clearly explicitly in the form of Lehman's
spectacular default last year. Many counterparties that did
not actually fail last year, their ability to act as service providers
to the many financial institutions they support were dramatically
compromised. That can make a very significant difference to a portfolio
as well. You can have the best-structured portfolio in the world, but if
it's all sitting with one counterparty or if it's exposed to one
service provider, that can have a very material impact on your returns,
and that ultimately is not a form of risk you are paid to take. It's an
expected risk, it's understood that it is there, but the principal form
of risk one expects you to be paid to take is market risk. However, one
must be very cognizant in managing all of those other incidental risks
that can be very material to the ultimate returns you generate.
