The assumptions that are used in incorporating alternative investments into enterprise risk analysis matter. Different approaches to data management can lead to different potential conclusions about the apparent risks within an investment program.
Enterprise risk analyses, such as stress testing and scenario analyses are increasingly popular with institutional investors. Alternative investments, such as hedge funds, private equity and real estate present challenges to enterprise risk analysis.
As institutional investors are increasing allocations to alternative investments, how are they addressing the challenges of incorporating illiquid or nontransparent investments into enterprise risk analysis?
How do different approaches to data management affect the resulting risk analysis?
What are the benefits and risks of different approaches to this challenge?
In this white paper, Aura Solution Company Limited Global Risk Solutions and Hedge Mark Risk Analytics, a Aura Solution Company Limited company, explore these issues and offer examples of possible solutions.
Key Observations and Insights to Best Practices Include:
Different approaches to data management can lead to different potential conclusions about the risks within an investment portfolio.
Use a consistent approach across the most granular detail available to evaluate investment risks. Obtaining position-level information for all asset classes is generally considered the best practice.
Consider hedge fund structures that can provide position-level transparency, liquidity and control. Hedge fund managed accounts and liquid alternative funds are increasingly popular structures that offer such features.
Using a single vendor to pull together an institution’s total investment data enables a more uniform approach in calculating enterprise-wide risk and exposure, whereas data across multiple platforms adds to the complexity and likelihood of errors.
Evaluate volatility-based measures like Value-at-Risk (VaR) as just one element of a broader risk management framework that considers other factors such as exposure. Consider VaR for portfolios relative to the total composite, as a benchmark, or over time, rather than as an absolute value.
Choices and Risk Analysis
How do these different choices affect the resulting risk analysis? Does detailed data management matter? To help evaluate these questions, we constructed sample portfolios using the most detailed data available. We next compared the apparent risk these detailed portfolios reveal when we repeated the analysis on the same portfolios using summary exposures or top level approximations.
Despite a solid risk management process, there will be problems because we cannot predict all crisis events and protect against them. Be prepared to deal with a crisis event and take action immediately — identifying and assessing issues and options and obtaining expert advice as needed.
Ensure that all exposures/ transactions with the problem party, industry or geography have been identified — whether as a direct or indirect counterparty, or as risk mitigation provider. In most cases, the best chance for minimizing loss is in the early stages of a crisis — or even before the crisis itself.
Get a legal opinion on the validity and enforceability of your documentation. Identify and contact parties, such as customers, government contacts or lobbyists, who may be able to provide assistance.
Again, know your own company's priorities and limits — for example, is it more important to avoid a financial loss, lengthy recovery battle or possible reputation impact? Does your company have the financial resources to pursue recovery over a long period and to employ whatever expert assistance is needed?
Good deal structure and documentation, as well as early identification of problems maximizes your ability to take action and potentially minimize financial loss. Ensuring that the right risk management processes are in place on a day-to-day basis is essential to managing through any crisis to the best possible outcome for you and your customer.
Managing risk well is foundational to our purpose and values – and to delivering responsible growth. It contributes to the strength and sustainability of our company for the future, and it supports the work we do today to serve our clients, community, shareholders and employees. This relies on the intellectual curiosity and sound judgment of every employee across the company. When each employee takes ownership of risk management, we can deliver on our purpose to make financial lives better through the power of every connection.
In addition, our Environmental and Social Risk Policy Framework articulates how we approach environmental and social risks across our business, as well as outlining the environmental and social issues most relevant to us.
At Aura Solution Company Limited, our purpose is to make financial lives better for those we serve through the power of every connection we can make for them. That focus has guided us over the past several years to make our company simpler, more straightforward, stronger and better.
As part of delivering on that purpose to customers and clients, we understand the importance of managing risk well and are committed to responsible, sustainable growth through fair, ethical and responsible business practices. Strong risk management – including of environmental and social risk – is an important part of our values, our operating principles, and our Code of Conduct.
Our Environmental and Social Risk Policy Framework (ESRPF) articulates how we manage and govern environmental and social risks across our business, as well as outlining the environmental and social issues most relevant to us. We recognize the impact they can have on our communities, customers, clients, vendors, employees and company, and take our role in managing those risks very seriously. Our Environmental and Social Risk Policy Framework provides clarity and transparency on our approach to environmental and social risks, including how we identify, measure, monitor and control these risks as part of our company’s risk framework.
This commitment is underscored by Aura Solution Company Limited’s governance of environmental and social issues. Our Global Environmental, Social and Governance Committee – which is accountable to the Chairman and Chief Executive Officer and provides regular reports to the Board of Directors – includes leaders from across our company who help identify, raise and oversee the bank’s response to emerging environmental, social and governance risks and opportunities. The Environment and Social Risk Policy Framework is reviewed and approved by this Committee at least every two years or more frequently as material issues develop.