Investment Risk Management / Edition 1 available in Hardcover
- ISBN-10:
- 0470849517
- ISBN-13:
- 9780470849514
- Pub. Date:
- 01/30/2004
- Publisher:
- Wiley
Hardcover
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$140.00Overview
Product Details
| ISBN-13: | 9780470849514 |
|---|---|
| Publisher: | Wiley |
| Publication date: | 01/30/2004 |
| Series: | The Wiley Finance Series , #257 |
| Pages: | 224 |
| Product dimensions: | 7.07(w) x 9.84(h) x 0.72(d) |
About the Author
Read an Excerpt
Investment Risk Management
By Yen Yee Chong
John Wiley & Sons
ISBN: 0-470-84951-7Chapter One
Introduction to Investment Risk
A walk in the investment maze faces millions every day in our global trading community. There are countless investment opportunities right under our noses. Some are good, others smell instinctively bad. But, how are we to know if the whiff of the business opportunity is really "off", or does our nose fail us? The scent of prestige used to be a leading indicator for investors. Yet, there have been spectacular failures at Andersen, Enron, Global Crossing, Tyco, Worldcom, Marconi, Equitable Life, Swissair and Sumitomo. These show that the value of a "big name" firm can be dubious. What have we really bought into?
Management theory, backed up by advanced information technology, would like to come closer to guaranteeing a sound investment choice. Investment experts bring the risk and return together. But, the danger is that final selection is still based upon prestige and not value. It is worse when this value is exposed as fraudulent. An analytical survey of fraud in the USA found that firms were losing about 6% of their revenues to occupational fraud and staff abuse. This was estimated to be worth $400 billion. Furthermore, even good companies suffer from strategic misdirection by the executives, and their investors may find themselves on the sidelines watching the ship go down. We can be average at investing, and if the boat is sinking we are evenworse at influencing the decisions of large corporations. H. Ross Perot said that trying to change the plans of the General Motors leaders was like: "Teaching an elephant to dance."
DREAM VERSUS RUDE AWAKENING
Modern business theory has, undoubtedly, left us richer to manage our investments. Pricing theories and various portfolio models have provided a foundation for building future wealth. Later and more sophisticated theories have incorporated a discount for that omnipresent element in all business activities - risk.
No enterprise is immune to the dangers that constitute risk. Yet, risk is in itself a good driving force to promote greater or more productive effort - the stock market feeds off two key motivators: fear and greed.
Greed is a unidimensional factor that eggs us on to increase profits. There is no law that defines greed as an intrinsic criminal offence; CEOs and directors have been quick to extract as much pay and benefits from a company before they leave. Yet, excess greed comes before a fall. They should come to fear regulator and shareholder activists' counter-attacks. Fear is the expression that we are about to suffer damage in some manner, primarily financial loss on the markets - we call the damage a potential hazard. Excess fear leads to stasis, and eventual business ruin. Risk is an ever-present factor in any enterprise, and profit is regarded as a proper reward for bearing the risk in the first place. The notion of a risk-reward ratio comes in, and the concept of "acceptable level of risk" is a natural result.
Risk management is the modern discipline that answered the call to handle business risk; the prime example being company failure. Many of the failures listed above cannot be attributed to criminal acts - corporate fraud and CEO theft reflect sentiment that is fine for the sensationalistic press, less so for the court room. Furthermore, a company director is rarely brought to court for losing control of a company. It is extremely unlikely that they would have the personal assets to come close to refunding their shareholders in full. Insurance premiums are rising, and there is no guarantee that pay-outs are increasing pro rata; you get an insurance company's assessment of damage, not your costs of replacement. In view of these shortcomings, traditional legal and insurance avenues of redress are not to be leant on as a crutch. A new look at risk management is required.
This book targets those risk factors that threaten a loss in our portfolio value or investment. We adopt a view of business investment as a closed project. This enables us to use a more disciplined analysis of what governs enterprise success, and that involves project management. We focus upon what constitutes investment risk; how organisations handle investment risk; how we can manage investment risk better. Briefly speaking, we can bring sound engineering and actuarial tools to examine risk and risk management in depth. Forensic accounting is needed for a deeper investigation of a company over its statistics and corporate personalities. These views are, oddly, absent in many business books on risk management. These financial engineering methods are useful for the banking and fund management sector.
Everyone harbours a dream, and high profits without risk are the ideal in the financial world. Saving is the obverse of consumption and real-life pressures come to the fore to make achieving this dream more problematical. Returns are dropping on average, as the recent falls in the global stock exchanges have shown. Furthermore, the world's population is continuing to age, certainly so in the major developed nations. Pension funds are now reducing their benefits and/or finding themselves under-capitalised. So, where is the dream now?
The changing demographics mean that, per capita, fewer people of working age are supporting more retired folk. Pensions form the biggest average holding by value of any household, more expensive than their personal house. Add up all these pensions and they form the largest fund of private households in most Western countries. Pension fund managers and institutional investors now exert a larger block vote upon corporations than the majority of private investors. For example, CalPers and Teachers TIAA-CREF are large funds in the order of $148 and $270 billion, respectively. They are influential in the field of corporate governance - one example being their near-success in scotching the HP-Compaq merger.
Sadly, people often devote more attention to their house and all its accoutrements, rather than choosing their investment. They pore over home furnishings or kitchen equipment, but their choice of pensions comes last. Some CEOs, like Dennis Kozlowski of Tyco, preferred to use company funds to help deck out his apartment in style. It is no surprise that the public patience with modern corporate leaders is wearing thin. The CEOs' avowed duty to shareholders is now plainly exhibiting a tenuous link to reality.
People are beginning to experience real disappointment when their pension returns are given upon retirement. A Robert Maxwell comes along occasionally to rob a pension fund, or an Equitable Life fund catastrophe occurs to destroy public confidence in the future. But these crooks are in the minority. Can the public prosecutors ever prove conclusively that there was any criminal activity within the Tyco, Marconi or ABB losses? Given this doubt or mistrust, should the public pull all their money out of pensions and invest it elsewhere? If so, where? This disillusioned attitude alone would lead to a strain on the pensions system, particularly that managed by the professionals.
It is said that wars are fought over oil; yet, the 21st century could see the real investor battling over corporate profits, and the pension funds will figure largely. The changing demographics of the larger older population stresses pension funds to provide for the retired. There will be a stark separation of expectations and reality as people struggle with the net sums left to survive on. The new defined contributions plans and the closing of some pension funds to new entrants further splits the retired world into the haves and the have-nots.
Yet, investment funds such as Fidelity Investments - the world's biggest fund, will definitely continue to be numbered among the "haves". Furthermore, with nearly $900 billion in assets under management, such funds will move stock markets around the world through their sheer size and influence. Investment funds will continue to exercise significant authority upon how money is invested.
More recently, some funds have become vocal advocates for socially responsible investment, such as the Coalition for Environmentally Responsible Economies (CERES) with more than $300 billion in assets. It is not just a mere focus upon corporate profits, but an explicit drive for accurate institutional reporting. These are to be conducted under stricter ethical guidelines on environmental, economic and social grounds.
Recent years have not been entirely kind to funds. Fund managers could have lulled themselves into projecting glowing consistent returns of 10+% p.a. on the stock market. Now, a long-term average of 4% to 6% p.a. could seem more probable. We have to link reality to a suitable investment risk vision. Furthermore, a fall of -25% was not only realistic, but a sad result in many stock exchanges during 2002.
We are faced with the snowballing prospect of client and business pressures to "beat the market" in finding returns to investment. Over-eagerness is an enemy of caution, and that can only lead to added danger or "unreasonable risk". We look to restore a balance between risk and return within this book.
BOOK STRUCTURE
This book looks at the uneasy marriage between investment and risk. Given the importance and increasing role of funds within the markets, there is an emphasis upon institutional investors. We have aimed this book towards those who work in the banking, fund management and insurance sectors. It does not take a pure accounting, engineering, IT, banking legal, or insurance treatment of risk - such a limited stand would probably impoverish profitable analysis. There is input from the actuarial and the forensic accounting professions, and methodologies from the project management discipline.
This is a synthetic view of risk management, also looking at the organisations that operate in the financial sector. The manner in which people work together to reduce risk is analysed in organic risk management. Previous studies of risk management have concentrated too much on the mechanics and numbers - this is not a healthy fixation.
This has tended to cover a multitude of reasons for risk or business hazard. The dangers of operational risk, and proposed solutions, will be detailed in later chapters. This introduction to the category of risk known as operational risk is within Chapter 1.
We look at the concept of risk, and the undeniable link it has to return in Chapter 2 "The Beginning of Risk".
The basic union between risk and return is detailed in the summary of results borne out in the early study of portfolio management within Chapter 3 "Investing under Risk".
The divorce between reality and theory has worsened under recent corporate failures. Shining the occasional spotlight on previous business cases helps the reader to understand the course of investment history in Chapter 4 "Investing under Attack".
Explanation of the leading trends in investment theory and financial regulation offer the benefit of making better-informed decisions based upon an investment methodology. These are examined in Chapter 5 "Investing under Investigation".
So, learning danger signs from past failures offers a profitable business warning radar for professional investors. These are outlined in Chapter 6 "Risk Warning Signs".
Technology has played a large part in the development of risk management as a modern business discipline. We examine some of the state-of-the-art financial techniques and their associated IT-based risk management systems in Chapter 7 "The Promise of Risk Management Systems".
Yet, technology never solved all our business problems. There is some prospect that demystifying current investment dogma will offer a better and balanced return in the future. We present an overall view of realistic risks in Chapter 8 "Realistic Risks".
Over-simplification of some business ideologies led us into a false lead of risk management. One symptom was the classic "one-size-fits-all" business response.
Financial leaders have reworked business theory and regulations into a more appropriate cogent investment strategy. One such development is the release of the new banking regulations for banks around the world known as the "Basel II" guidelines. Their new views on banking risks are outlined in Chapter 9 "Risk-managed Banking and Basel II".
The evolving paradigms on investment risk have led to new ideas on modelling risk. These are summarised in Chapter 10 "Future-Proofing against Risk".
Visiting the past has shown us the potential graveyard of many previous, proud companies and investment dreams. Even a current examination of the current state of investment risk management demonstrates the splintered thinking of the business community. The business orthodoxy is hide-bound by mechanistic theory; we require treatment of corporations more like living beings requiring "organic" risk management. These can, and should be, joined up by integrated risk management detailed in Chapter 11 "Integrated Risk Management".
Whether we engage in simple personal investments, or much larger and more complex corporate business decisions, we can all benefit from risk management to preserve the value of our investments. These are summarised in Chapter 12 "Summary and Conclusions".
(Continues...)
Excerpted from Investment Risk Management by Yen Yee Chong Excerpted by permission.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
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Table of Contents
1 Introduction to Investment Risk.Dream versus rude awakening.
Book structure.
2 The Beginning of Risk.
Risk and business.
Case study: The shark and its risk.
Case study: The ruin of Crédit Lyonnais (CL).
Case study: ABB engineering.
Investment scams.
Banking risk and sharks.
Risk management as a discipline.
Humans and risk.
Case study: High-street retail store losses.
Case study: Allied Irish Bank (AIB).
The state of the investment game.
Risk types.
Reputation risk.
Case study: Equitable Life.
Credit risk.
Market risk.
Operational risk.
Risk and damage.
Viable alternatives.
3 Investing under Risk.
Human behaviour and investment choice.
Portfolio management.
Value-at-Risk (VaR).
Monte Carlo simulation.
Collective use of mathematical tools.
Position keeping.
Investment managerial control.
The treasurer’s role.
Trading and risk management.
Investment risk experts.
Case study: A large UK PLC defined benefits pension fund.
Who controls whom.
4 Investing under Attack.
Investor disenchantment.
Risk-bearers and risk-takers.
Professional investor/shareholder.
Investment companies/fund managers.
Investment banks.
Auditors.
A look in the risk mirror.
Risk-averse.
Risk-neutral.
Risk-takers.
Investor analysis.
Types of CEO – birds of a feather.
The CEO eagle – The M&A addict.
The CEO dodo – Risk-phobic.
The CEO ostrich – Risk-ignorant.
The CEO owl – Risk-acceptable.
The CEO magpie – Risk-seeking.
Company structure and risks.
Case study: The executive background check.
Risk vanities.
Pensions mis-selling.
Case study: Boo.com.
Corporate misgovernance.
Accuracy of corporate losses.
Classes of instruments and their risk components.
Derivatives.
Bonds.
Equities.
Investment as a project.
5 Investing under Investigation.
Instinct versus ability.
Checking corporate fundamentals.
Formulate a business plan.
Due diligence.
Risk support and methodology.
Investor cynicism.
Case study: LTCM.
6 Risk Warning Signs.
Prevailing risk attitudes.
Reputational risk.
Case study: Enron.
Airborne early warning (AEW).
International accounting standards (IAS).
Credit ratings.
The ratings procedure.
Business lines.
Law and risk management.
Case study: the UK Football League.
What the law covers.
Completeness of contract.
Case study: Merrill Lynch versus Unilever pension fund.
Sarbanes–Oxley Act for audit control.
Insurance.
Risk retention: self-insurance.
Case study: Insuring big oil projects.
Case study: the Names and Lloyds, London.
Sharing, transferring or mitigating risk.
Search for risk management.
Alternative theories.
Causality and managing investment risk.
Value-added chain.
Risk management to pick up the pieces.
Scenario analysis.
Case study: Business Continuity, lessons from September 11th.
Case study: Guaranteed annuity payments.
Stress testing.
Bayesian probability.
Artificial intelligence (AI) and expert systems.
Case study: Anti-money laundering.
Risk maps.
7 The Promise of Risk Management Systems.
Current state of systems.
Risk management methodology – RAMP.
Activity A: Analysis and project launch.
Activity B: Risk review.
Activity C: Risk management.
Activity D: Project close down.
Financial IT system support.
The Basel II Loss Database project.
Case study: Algorithmics systems in a bank.
Integration and straight-through processing (STP).
IT systems project failure.
Case study: IT overload.
Tying financial system functionality to promise.
Risk Prioritisation.
Giving the go-ahead.
Building risk management systems.
Finding the “best” risk management system.
The invitation to tender (ITT) process.
Business functionality requirements.
User’s functional priorities.
Business flirting – the user’s system specification.
Business flirting – the supplier’s reply.
Judging the ITT beauty show.
System priorities.
Project life cycle.
Risk management project plan.
A – Our risk strategy.
B – Risk review.
C – Risk management.
D – Project close down.
8 Realistic Risk Management.
Intentional damage.
Fraud, theft and loss.
Fraud perceived as the main criminal threat.
419 – not a number, but a way of life.
Operational risk in emerging markets.
Parachuting in the experts.
Case study: Chase Manhattan in Russia.
Unintentional damage.
Case study: Split capital investment funds.
Rogue staff.
Exposure to fraud at the top.
Exposure to fraud lower down the rung.
Case Study: Deutsche Morgan-Grenfell, 1996.
An operational risk perspective.
Operational risk protection: the “roof”.
Investment project growth.
Phase 1: High skill.
Phase 2: High performance.
Phase 3: Client growth.
Phase 4: Asset growth.
Case Study: Soros Quantum Fund and Buffett’s Berkshire Hathaway.
Phase 5: Skill decline.
Investor risk skills.
Investment management skills in the market.
Hiring star managers and CEOs.
Investment managers and governance.
Creating a winning fund management team.
Building for investment resilience.
Moving ahead from the investment herd.
Recap on operational risk.
9 The Basel II Banking Regulations.
Current banking problems.
Basel II – a brief overview.
1 Pillar one: Capital requirements.
2 Pillar two: Supervisory review.
3 Pillar three: Market discipline.
Cost-benefits under Basel II.
Risk for financial institutions and insurance.
The Basel II OpRisk principles.
Loss database.
Loss database drawbacks.
Scenarios for Basel II OpRisk.
Next steps: After Basel.
10 Future-proofing against Risk.
Moral hazard.
Risk detection.
Case study: Marconi.
Risk countermeasures.
Case study: The Yakuza and shareholder meetings.
Risk firepower.
Case study: Huntingdon Life Sciences (HLS).
Insurance: the buck used to stop here.
Risk monitoring.
Case study: WorldCom.
Forensic accounting.
Appropriate risk management structure.
Case study: BCCI bank.
Facts, not figures.
New risk focus.
11 Integrated Risk Management.
Developments in the finance sector.
Organic risk management.
Separating reputation from risk management.
Case study: Enron.
Future for risk management.
The case for organic risk management.
Case study: Hunting for staff deceit.
Unintentional (ostensibly) and legal.
Intentional and illegal.
The reigning investment ideology.
12 Summary and Conclusions.
Summary of risk management.
Identify stakeholders and interests.
Match risk appetites.
Match risk time horizons.
Organic due diligence.
Value for money.
Reputation risk.
The corporate governance model.
Hitting back.
Keep your eyes on the prize.
Conclusions.
Index.