Risk management: What do allocators expect?

Transcript

GREGORY CHOUETTE: So really, as we discussed and as we all understand, risk is a complex issue. To be relevant, it really needs to be tailor-made. There is a strong requirement for understanding the strategy and making the framework really adapted to put together a strategy of funds. So one size fits all just doesn't work and is irrelevant, largely. So the objective really here is to help promote best practice in risk management.

And thank you again for having shared, also, in putting this paper together. So I'll ask you to introduce maybe yourself. So maybe starting with Matt Barrett from Kepler Partner. Do you mind telling us about yourself and Kepler a little bit, please?

MATT BARRETT: Absolutely. Good morning, everyone. Thank you for your time. So by way of introduction, my name is Matt Barrett. I'm a partner at Kepler Partners and head the manager research team.

For those of you who don't know the business, we were founded in 2008. And since 2010, have really tried to carve out a niche, particularly in the alternative UCITS spectrum -- so hedge fund strategies but in the UCITS format.

In terms of service offerings, there are a couple. But principally, one, we have a number of advisory relationships, so acting as, essentially, investment consultants to a range of allocators, so allocating money to external hedge funds.

We also run a UCITS platform where we are partnering with third party hedge fund managers to bring their strategy into UCITS. I would say that gives us quite a unique position in many ways in terms of really seeing, you know, risk from multiple perspectives. One is potential allocators into funds, but two, also as product providers that gives--

We really get to see under the hood of a lot of strategies which is very different to when you're sitting there externally. So I think that gives us kind of a 360 position in terms of understanding risk of investing in strategies. Prior to Kepler, I was at HSBC and started my career as a long-running asset manager at Baillie Gifford in Edinburgh.

GREGORY: Great. Thank you, Matt. Caroline, it's great to see you today. Do you mind introducing yourself and Rose Hill Park?

CAROLINE LOVELACE: Sure. Thank you for having me. It's a pleasure to speak to you and to the audience out there. My name is Caroline Lovelace. I'm the founder and managing partner of Rose Hill Park. Our strategy is as all-around emerging managers, exclusively looking to direct and provide seed capital to both hedge funds and private equity.

We are agnostic as to strategy. We're looking for new strategies that have an interesting perspective on some of the more major strategies like long-short equity, but perhaps it's a sector strategy as well as credit. We also look at private equity as well. And we have a focus but not exclusive on women and minority-owned managers and that includes in the U.S., Europe and Asia.

GREGORY: Great. Thank you, Caroline. Matthew, hi. Good to see you today. Do you mind introducing yourself and Investcorp-Tages?

MATTHEW STILING: Thank you, Gregory. Hi. So I'm Matthew Stiling from Investcorp-Tages. We are a joint venture between Investcorp's Absolute Return business and Tages’ legacy, multi-manager business.

Similarly to my other panelists today, we also have a focus within the seeding aspect as well in emerging managers where we have been quite active in that particular area.

As a result, dealing with a lot of emerging managers, especially through the seeding aspect, we really do gain a good grounding on day one with our managers to help guide them through, obviously, the process of becoming a much larger manager and a much… in terms of bringing up the aspects of best practice.

We also have a UCITS platform as well where, again, we work with external managers, again, to offer them services applied across that product as well.

Again, similarly, we're fairly agnostic. We look across UCITS funds, traditional hedge funds, private credit funds. And we have reached out into the impact area as well where we have a strong ESG Portfolio Manager focusing on social impact within Europe.

GREGORY: Great. Thank you, Matthew. Excellent. So we'll start with the first topic that we discussed on the paper last time, is about independence of the risk function.

So, obviously, having an independent risk function has now become the norm. There is an understood need for balance of power, having someone that has a strong voice outside of the investment team and having the ability to calculate even risk exposures on an independent basis to bring this different perspective. But we know that this is not always simple to implement.

So I'll turn to you, Caroline, for the first question. Obviously, we discuss that in our conversations. And then particularly, it might be difficult for small managers to have this distinction and having this truly independent function. Can you tell us a bit more about that?

CAROLINE: Sure. I mean it can be difficult to have that kind of independent function internally because, obviously, emerging managers tend to be quite small. They don't have necessarily the number of personnel to create that division and that independence. But I would say there are a couple of ways, early on in the managers’ lifecycle, that they can create that independence.

First of all, I think a big one is to lean on your service providers. There are a number of service providers and that includes sort of from prime brokers to administrators who've developed kind of mini risk functions. They don't necessarily provide all the functionality of a dedicated risk system but they do provide some interesting information with regard to performance and risk analytics, and that's just something that a lot of external service providers have created just to become competitive in the marketplace.

So by leading on these external service providers, you create a sense of independence. It's their risk engine. They're able to draw in the positions, not from you but from their own systems as an administrator or as a PB exactly from the trade flow. So that provides a level of independence, at least in the interim, that investment allocators can feel good about and feel comfortable with.

I would also say that you can also create a… advisory board that tends to be in a private equity area as opposed to hedge funds. But if you can bring along some of your colleagues from, say, your previous work life who have a good reputation, that can be helpful in terms of creating some independence around risk.

I mean, the last thing I would say is, what a lot of… and this may be a little controversial because… I mean managed account platforms can also provide risk systems and that can also provide a specific… Because of the sort of the risk guidelines within the managed account platform, that provides another set of eyes which manage exposures.

But I'd say as an emerging manager, you don't want to build your business around having managed accounts. What we have done in the past is create a managed account which we seed and then any subsequent investor can also invest in that managed account.

So essentially becomes a commingled fund that sits on a managed account platform and therefore, you basically get sort of the best of both worlds for both the emerging manager as well as creating the kind of risk guidelines and risk oversight that allocators can feel comfortable about. It’s not something for everyone but it's something that emerging managers can consider.

GREGORY: Great. Thank you, Caroline. Yeah, certainly, this innovative solution around managed account and commingle fund solution that you mentioned is very interesting, as well as leveraging all your service providers in the best way possibly can is obviously a sensible approach.

And a second topic that we discussed quite a bit was about the risk management framework. And so the importance of having strong documented policies and set of guidelines that explain both things like soft limits or hard limits as well as pre trade versus post trade, and trying to have that really documented and really also trying to go further than the basic regulatory “Check the box,” essentially, so the idea being trying to stand out of the crowd, how can managers do to show a little bit more of innovation and intelligence around those processes?

So I'll turn to Matthew Stiling for this question, as somebody who works on the due diligence’ side. What are the most efficient set of policies and documentation and risk management framework and governance you've seen?

MATTHEW: Absolutely. I mean, obviously, from the operational due diligence point of view, the first instance you're going to see these policies are in the underlying offering documents for the fund.

So really, what they need to be able to do is they need to be able to demonstrate, first of all, what the strategy is at the manager and then how, on a more general term, that risk profile is then being fit within, obviously, what the manager wishes to achieve to fulfill those objectives.

Obviously, on the same side of that as well, that also implies the governance structure at the fund level. So that's really kind of our base case starting points.

And then as we drill down into probably what is the most useful document from an ODD point of view after the offering doc from a risk perspective is actually having a risk management policy that clearly defines the methodology you're going to use and the internal limits you're going to use to actually fulfill those objectives that you're basically displaying in the offering documents.

Now, this could be, you know, how the methodology is set out for how you're going to use VaR models, for example, kind of sensitivity analysis but then, obviously, beyond just the general methodology as well. Again, what we want to see is the governance of that methodology. So there's not always going to be an off the shelf package that fits all situations.

So what the risk management policy document should really do is the evolutionary in its own respects where there are going to be risk limits that are breached.

So from a post-trade situation, what you want to see is you want to be able to see the identification of those potential or those limit breaches, how those are then rectified, and then almost a reflection in terms of looking back and saying, right, “Where in the process does this need to change?”

So really, between the two, you've got the… you know, looking on a post-trade basis, you've got, what is methodology being used and is it fit for purpose as the world evolves, you know.

A particular example, I'm looking at VaR models. For example, in March 2020, there were three days of trading that really affected historical VaR modeling. So as a result, what we've seen is a lot of managers have evolved their VaR methodologies.

As a result, to take that into consideration, they've incorporated lags as well in their models. They've looked at diversifying the VaR across from 95 percent to 99 percent in steps, obviously, within the regulatory framework but just looking at it from a different perspective to see how that fits with the trading strategy they're performing at that time.

GREGORY: Thank you. And yes, we certainly saw similar instances around COVID or more recent spikes in volatility is when, really, you're calibrating on a model on a very low volatility environment. And all of a sudden, you have what was called “Unprecedented” and what became too many unprecedented events.

Essentially, that makes your VaR being breached so many times and having too many exceptions in a way that is unexplainable but really, because your calibration was not custom and accurate. So good points here, Matthew. Thank you for that.

The next topic we discuss quite a lot with the three of you was the various lines of defense. So rethinking about risk in a number of different line of defense, where the idea is having a first line of defense, which is really the risk embedded within the strategy. So it could be either on desk risk management or it could be fund managers themselves having more of this first line.

The second line is more of an independent risk review here, the idea being that having someone else that will calculate your daily risk report and having some limits around it.

And then the third level here is more of a group risk function, more from a governance standpoint, looking at more of an escalation... formal escalation of real structural issues or changing… Again, more structural points like your risk management policy, as Matthew explains, or thinking about your VaR model, things that you don't want to rush into on a daily basis but you need to think about more strategically. So maybe you're starting on the first line of defense that we discussed with Matt.

During our discussion, you mentioned the importance of having this on desk risk manager that understand the strategy almost as well as the fund manager himself. Can you talk about that a little bit more?

MATT: Yeah, absolutely. So taking a step back, I always think that allocating to managers and doing manager research is… It's really a mosaic exercise in that you've got lots of independent pieces of information all of which build up to give you a holistic picture.

Clearly, risk is a very important line of that but you shouldn't look at sort of risk in isolation. It's very important to understand the context in which risk management is happening. So context is really important.

And one size definitely doesn't fit all. There are so many things which ultimately impacts the risk of a strategy. Obviously, the nature of a strategy, which is something that I'll go on to touch on later, but particularly the context, it's happening.

For example… I could not name them but plenty of equity long-short funds where they have very good codified risk management processes, independence of risk function. But I know, at the end of the day, the portfolio manager in that firm is king and ultimately is going to do what they want.

So we could be sleepwalking into a situation where we feel very safe but we know, because of the context of that understanding, that that's not the case. It's very important to incentive structures. All of these things really build up this kind of holistic picture of risk.

To answer your question directly, thinking about, you know, slightly different strategies, if I'm looking at a 30 stock, long only U.S. equity portfolio, we can probably all work out roughly what the risks of that strategy are. It's relatively vanilla strategy.

Quantitative approaches to risk management are likely to catch it -- you know, large amounts of the actual substantive risk of that strategy. But then, particularly when we go into the hedge fund realm, clearly, complexity goes up significantly.

For example, we work with a relative value arbitrage manager. It's essentially a single portfolio but multi-strategy approach. So they're allocating convertible bond arbitrage, equity arbitrage, which includes hold codes, warrant arbitrage, pairs trading, some merger, they do some credit strategies, and then volatility arbitrage strategies.

The net result of that is a portfolio which has a significant number of line items, you know, two to 300 positions. But particularly, because of the nature of the securities that they are trading, they are, by nature, very idiosyncratic. Warrants, for example, this particular manager has been very active in SPAC warrant arbitrage.

You know, these are typically very new securities. So they don't have a trading history, which is, obviously, a limit to current quantitative risk management techniques. They're often quite esoteric legal structures and there'll be very specific provisions.

Warrant A is not the same as Warrant B. So you really, really, I think in that scenario, need to have, you know, a risk manager who actually understands the product.

And then when you think about putting all of these positions together, sure, there might be 300 line items but half of those positions, using round numbers, are there as risk management tools. It's a relative value arbitrage. So they're designed as risk reducing.

And so you end up with these… maybe a 300 line item portfolio. But you're actually talking about packets of related securities as a sort of arm's length risk manager. How the heck are you supposed to see the wood from the trees across all of these different instruments, auctions, delta one, etcetera, etcetera?

In that instance, for those particular types of strategies, I gained a lot of confidence when I speak to the risk manager in that they actually understand what the instrument is, what the portfolio manager is trying to achieve through those positions, and then can actively feed into… actually the portfolio management process in terms of, “Let's try and squeeze out risks that you're not intending to take.” Whereas, clearly, someone who's just sitting at arm's length, sending them a bunch of VaR reports is very unlikely in that instance, to capture the true substantive risk of that strategy. So this thing is, “One size does not fit all.”

And particularly, you know, the more complex strategies on desk risk management is very important because they can truly get a sense of what the risk is rather than just, as we've seen many times, relying on… I mean, arm’s length to the risk management models, which doesn't really keep the investors safe.

GREGORY: Yeah. Thank you for that, Matt. Obviously, the examples of having this undescript person that knows prospect use of a bond in a high level of details and he's able to really challenge the manager and looking at the investment really but from the risk standpoint is something that is very valuable.

And as you said, we've seen a lot of examples where in the SPAC quarter last year, for example, where risk systems aren't covering them at all. So it was really about being able to be customized and being able to build something that, first, will cover them, and second, in a way that makes sense. So I think it was very points. Thanks, Matt here.

For the next question. I'd like to ask Matthew, essentially here, this idea of an independent risk review. So you talked about the risk function that should be governed by formal committee and that formal committee should really include, say, your non-investment members but that have some expertise and those ability to really challenge and have the credibility to change the investment team.

Another point you mentioned was also the transparency, the need for this high amount of transparency. Can you tell us a bit more about this approach?

MATTHEW: Absolutely. I mean, to follow on from Matt's point, obviously, where we have that understanding of the risk function by someone that is, say, one step removed directly from the investment team, that allows, obviously, a level of independence at the first level, when we talk about the greater picture of governance in respect to--

Although it's not completely independent, it is the first step in reporting, say, to the board, be that on a quarterly basis, depending on when the board meets, but also in the interim as well -- if there are any ad hoc situations where there is a breakdown at the risk management framework. And there is the need for the point of escalation you can do so.

So again, having that person stand one step back and being able to look at that and say, “All right, well, this isn't working. Why isn't it working,” and then having the ability to… Again, as kind of Caroline pointed out, is to actually rely on service providers, maybe talk to your auditors about how you're looking at that risk in a particular way really does… apart from Independence, then start to create accountability as well on the back of that.

So yeah, so having the independent… as you pointed out, Gregory, it removes that tick box exercise approach. So the risk management committee, you know, it should be limited, and it should be accordingly escalated and communicated to the board of directors, so that they--

Fundamentally, you are in charge of the governance of the fund structure, alongside the GP are able to ask the right questions, which really emphasizes that concept of transparency because once you've started to build up that level of transparency throughout the governance structure, the messaging, as a manager as well, becomes a lot more coherent.

Eventually, when you talk to investors, who are the endpoints, who the governance structure is accountable to as part of the fund structure, then are able to actually communicate effectively what the message is. If there has been a breach in risk policy, for example, how that was rectified. What were the chains of command that we’re going through to get to the point where a decision was made?

So as a result of that, it puts the investor at ease because ultimately, if I find out… if I see, for example, large swings in gross and net exposure, I'm starting to worry. Does the risk management framework work appropriately?

And I start asking questions and kind of start front running the risk function of the fund that I'm doing due diligence on. And often in times, that will mean digging a lot deeper. Sometimes, then the investment manager would prefer.

So that level of independence and accountability effectively leads to transparency, which, as I said, just generally, I would say, leads to better communication with end investors. Yeah, breaches happen. We all acknowledge that. But we want to see a well-fit procedure to counteracting that and effectively managing that process throughout.

GREGORY: Thanks, Matthew. Thank you. And clearly, as I think we discussed as well, is helping also alleviate a little bit this relationship bias that might happen in the first line of defense where, really, if you're embedded in the risk team but you're in the investment team, that you are risk person, you're basically working very closely to the investment team. You have to in order to understand the investment. So there might be some relationship bias that gets built up here, so having this independence also is something that you pointed out might help.

MATTHEW: Absolutely. I mean, even having the risk analyst or chief risk officer leading that risk committee, again, just goes to show that there's a confidence in the individual that Matt was referring to earlier, that really allows that investment manager or portfolio manager to truly be challenged at an internal level, which, again, you know, that is also what the board of directors should be doing. That's one of the things you pay them to do for the funds.

So if you get that board of directors up to speed as quickly as possible, they can really start getting into the nitty gritty and really performing the role they should be doing as well as opposed to just, again, as you mentioned, being a tick box exercise.

GREGORY: Great. That actually takes us to the third line of defense. And my question to Caroline really here, where this is really the ultimate governance group risk ultimate oversight role. And we touched on this a little bit. But for a smaller manager, it can be difficult to put in place. So there are some examples you can give us of managers or situation where this level of control could be added despite their size?

CAROLINE: Right. I think it all comes down to documentation and… I mean, you know, both Matt and Matthew talked about this. I mean, when you have this policy document and you want to make clear that you're actually using it and that you're actually following it and to the extent that there is a situation where there's a breach or you have a situation, say, in, you know, March in 2020, where there need to be some sort of adjustments or changes, you document that and why and how. So it is a living document.

I would say for emerging managers, you can also be somewhat aspirational in that document, being clear about what you're doing now. But at a certain level of AUM, you would like to implement this change as well because it gives allocators and other interested parties a sense for where you're going.

And that's important because investors and emerging managers don't expect you to look like… you know, a 50 million or $100 million manager looking like a $2 billion manager. What they want is to know that you can get there and you understand the pathway and what's required of you. So I think that's the most important.

And to the level of granularity that you can… I mean, Matt made a very important point about trade packets. I mean, to be able to break down where your risk and performance is… where those elements are based on not just the line items but actually how the strategy is implemented is so key because--

Essentially, what an allocator wants to be able to do is not just understand your performance and risk drivers but also… Particularly with emerging managers, the expectation is that you're sure that they're going to have investments in a lot of other funds. So how do they determine their group risk if they're not able to assess what your piece of it is as an emerging manager? So I think providing all that kind of information for an allocator is incredibly key.

When you were talking about this question, an example popped up. I worked for a hedge fund of funds, you know, in a previous life, and we invested in only fixed income and credit managers at that time.

And, you know, people talk about 2008 but 2006 was really when the ABS and MBS market structure products started to break. And so we had one manager who basically… You know, we would have a month call and they talk about, “If A and B had happened, the funds should go up. If X and Y happens, the funds should go down,” talking about different scenarios where he thought his performance and risk were.

But as the months went by, he realized that sometimes A and B would happen. We thought it would go up but actually it’d go down.

You know, he was still performing but we ended up redeeming anyway because it was clear that his risk policy framework was not aligned with his strategy. You couldn't make sense of it.

So I think that that's just an important example about how the manager has to make sure that these two… that the policy and the strategy are aligned in such a way that it is actually helpful for the allocator and for themselves to understand and to better execute their strategy because if it comes apart then that's a huge red flag. That's just… You don't need to figure it out and just say, “Well, if I can't figure that out then I just have to probably walk away,” even if you're still making money for the allocator.

GREGORY: Great. Thank you. Thank you, Caroline. So maybe moving on to the last topic before we go into ending remarks is really the point about risk systems. I think you all mentioned that the quality of the system is crucial but also the way it's used and the way it's calibrated in a way that makes sense is probably even more important.

So on this one, can you tell us a little bit more about that? And in what way you think this adds value in the control process, in the portfolio construction and also ultimately for investors and the type of information that you like to see? You want to take this one, Caroline, and maybe I’ll ask Matt after that?

CAROLINE: Sure. I mean, I think it sort of goes towards the part of that example that I just gave around the ABS-MBAs manager, is that the manager should see… this risk system is not just sort of a burden for them. They should see it as an opportunity to understand better how they invest.

Matt also mentioned, you know, this idea of the CIO or the portfolio manager basically doing whatever they want, you know, in the end because they can.

I think that if you can demonstrate, that in fact you are using the information from the portfolio and risk system to be a better investor, then that's incredibly helpful.

I think that, you know, as allocators, we want to invest with talented investors, and we can look at their returns. But in the end, if they don't understand why they're making money really, in terms of the factors, in terms of a tray packet, then you don't necessarily understand whether or not it's a repeatable process. So I think that's really key.

And so looking for a system which can easily provide you with information as a portfolio manager that helps you become a better investor but then also can help you communicate better to allocators how you make money and how you control risk then that's the best kind of system that you can have.

GREGORY: Thank you. Yeah, often, risk is a way to retain capital and so is transparency in the sense of being able to explain why things go wrong so investors can understand as opposed to being faced to a situation they have no clue about. Then as a result, the default solution is to redeem. Matt, can I just--

CAROLINE: Can I just…?

GREGORY: Yeah, sorry.

CAROLINE: I’m sorry. Just to finish. I mean, to put a fine point on that, I mean, you, as an allocator, you understand that the fund is never going to always go up. I mean, we understand that.

So what we want to do is we just want to have an expectation about why you might experience losses and in what scenarios. And that gives us a kind of confidence to be able to say, “Well, this person knows how to manage risk.” And so that's really key.

GREGORY: Great. Thank you. Matt, we discussed that as well. Obviously, the regulator is also pushing for that, you know, things like liquidity, for example, where the requirements are always higher and higher for transparency. Can you tell us a bit about… What’s your take on this?

MATT: Yeah, absolutely. So, to me, I always feel that there's a bit of tension between this kind of… the thirst for data and knowledge. And definitely, we see it with our dealing with, you know, the regulator. You are risk pack on a quarterly basis. You know, you're probably adding 20 pages each quarter and then it ends up in this enormous tome.

And then theoretically, you're also bringing in many more stakeholders each time, you know, from the organization. So you can end up with risk committees, which, you know, become quite unwieldy. What are we supposed to do with, you know, a 400-page risk document and a committee of 15 or 20 people all with their various, you know, motivating factors?

So there's definitely a sort of… a fine balance. And then, again, to me, it just really comes back to, you know, this context point.

Yes, there's a lot of focus at the moment on liquidity. But, you know, the liquidity underlying assets in isolation, to me, it's actually quite academic because it's driven by how liquid your funds structure is, how concentrated your investor base is, what your IR or sales team view in terms of sales. Are we going to be seeing redemptions? Are we going to be seeing subscriptions? So it's really tough in that--

Again, this one size doesn't fit all because you want to end up with a structure and processes, data, etcetera, etcetera, which are, you know, commensurate and appropriate for what you're doing.

But the other thing that we've really noticed, which I think is a bit of an industry challenge, is different allocating groups wanting to consume risk information in different formats. And you can very, very quickly end up… You know, that really grows legs in terms of--

You actually think it's a good idea to do this dedicated risk report for investor A and then investor B wants a different one, investor C, and then suddenly, your risk function could theoretically be tied up in terms of--

They spend the entire month just creating various bespoke risk reports for the investors. Would it not potentially be better to take all the important bits in all of them, consolidate into one and come up with a… you know, kind of a much more holistic approach?

I don't know if that answers your question. There isn't really a kind of silver bullet answer, I think, to that question. But again, you've got to think about everything in context. At the end of the day, hedge funds, asset management is a business. And investment risk, you know, these are all just strands. You really need to sort of think about that. And then you really can try and capture the substantive risks both from an investor and business owner perspective.

GREGORY: I think your point is very well-taken, particularly when you mentioned about the burden on team to produce ever-increasing sets of reports including for investors and quite often, for small managers.

These ones who PM themselves are operation people who are not necessarily with team when they don't have a dedicated risk team. So this becomes even more of a problem.

Great. So just in the last few minutes, I'd like to ask the panel, for people who have joined us today in our thinking of growing their fund and use best practice, what would be your best piece of advice for them when it comes to risk management and attract institutional capital? Start with Matthew.

MATTHEW: Sure thing. I think at the end of the day, what you really need to focus on is the flexibility of your risk management system and the ability for it to evolve.

What we don't want to see is a static process, so to speak, and that really is solidified by kind of what we've mentioned in terms of the governance structure. If you've got a really good governance structure in place, it's very easy to adapt your risk management process.

So I would say that's really the big thing. I think, yeah, you should be able to happily share that with investors. What is your risk managed process? Are you open to the idea of change? If you are, what's the control mechanism around it?

Again, that just builds up the confidence of the underlying allocator, to knowing that the risk management process, if it doesn't work, which it doesn't always, is at least adaptable relatively quickly but also going through the right chain of command to do so.
So I think, you know, a lot of managers do very quickly underpin themselves in quite a rigid framework that doesn't really allow them to adapt.

And I think as we're getting in some more interesting situations, you know, volatility is back with a bang. We're going to see that really take a big influence on how managers look at risk management.

GREGORY: Great. Thank you, Matthew. Caroline, your best piece of advice?

CAROLINE: Yeah, my best piece of advice would be, “Don't skip a step”. I think when you're starting a fund, starting a business, there are a zillion things to do on your list to try and figure out but sort of integrate risk and risk control and risk systems into your thinking and your planning.

When you're talking to service providers, ask them what kind of information they have, what kind of risk and performance analytics they can provide. Sometimes, it’s free of charge or looking to independent systems like Landytech. Do that research because it is really, really hard to integrate it after the fact. And I've seen this--

I mean, just trying to figure out how to create the feeds that go between certain providers in order to create information that's usable in a portfolio when you need it, and you don't have time to do it once you started the business. So I would say just make sure you don't skip a step. That's important.

GREGORY: Thank you. Thank you, Caroline. Matt, can I ask, please?

MATT: Yeah, absolutely. So I really echo what the two previous panelists said. Definitely, don't have risk management as an oversight. It bugs me often when the risk management slide is Slide 30 in a 35-page deck.

And again, I'll keep banging on about it. But just making sure that you have a kind of a holistic approach to risk management.
And also, particularly in the early stages, don't be afraid to have the risk management conversation with your underlying capital partners. To me, again, don't be afraid to say, you know, “We're not doing it this way. We're doing it that way because we believe that’s most appropriate for our structure, our strategy, our model of governance.”

This sort of one size fits all, we can all draw down that sort of risk management best practice but it's not going to be best practice for that funds A, B, and C.

And don't be afraid to have those conversations because at the end of the day, it's a commercial exercise. You're trying to instill in your investors confidence that, “You've got this” and you've got a holistic understanding of risk.

I think there is a growing realization in the allocator community again that, you know, hedge fund is a business and you need to think about the business in all senses.

So by having that conversation early and making sure that it's appropriate, again, it instills in them confidence that you've captured what's actually relevant for your strategy rather than, “Yes, we've got this policy and this process.” You know, to Matthews earlier point, if it evolves, that's absolutely fine. I would rather it evolves than just stays rigid.

GREGORY: Great. Thank you, Matthew. If I summarize, “Be flexible. Don't skip the step and no risk management Slide 30, please.” So thank you very much for all your contributions. I'll hand over to Sam for the closing comments. Sam, back to you.

SAM FRANKLIN: Thanks, Gregory. We actually have a couple of questions in the Q&A. I don’t know if you can see those. Maybe we could touch on those very quickly.

GREGORY: So one of them, it was when we talked about three lines of defense, “Which one of the three is the most critical to ensure effective risk control, and if you had to choose one?” Anyone of you wants to take this on?

CAROLINE: They're all important. They're all important.

MATT: But with the greatest respect, you know, if you're asking those questions, again, I think you're approaching risk management in perhaps the incorrect way because, you know, they're all important. One will be more relevant for Manager A. One will be more relevant for Manager B. It's not sort of one size fits all.

MATTHEW: Yeah, just a round off, obviously, it's a circular motion, right? So you start off with your feet on the ground, you go up to your committees, you look at how you're changing your processes, and then it comes back around, so boots on the ground again.

GREGORY: Thank you, Matthew. And there was a question as well on… I think we touched on that already a little bit. But when we see under performance, how do you find risk reporting and transparency helpful to help manage relationships with investors?

MATT: So I'll jump in here, particularly, given that we specialize in UCITS which is a daily price fund structure. Investors have the “luxury” of seeing the good, the bad and the ugly, a lot of which gets swept under the carpet in monthly dealing structures.

We've found them increasingly to be incredibly reactive to bouts of underperformance, which is probably too much, almost to the level of looking at the daily moves.

And particularly, enter a more protracted period of underperformance. I believe it's never been more important, people just demanding more and more transparency from their underlying asset managers.

And the more that you can give them, the better because, again, this is about confidence. And if you can explain to people what's happening, why it's happening, why you're concerned or not concerned, what the appropriate action is, yeah, it's all about sleeping easy at night for everyone. And the last of those are all the better, basically,

CAROLINE: I mean I would add just one thing, is that within the manage account structure, you can give permissions for investors. We've had a seed investor and a fund who wanted to have additional information on a daily basis.

And, you know, sort of managed platform can often give you that kind of transparency. You won't get all the line items but you'll get aggregate performance and risk information and that, frankly, gives a lot of comfort to an allocator when they're investing in an emerging manager.

It also gets them up to speed much more quickly in terms of how the manager invests, how they manage risk. And that could actually help them to think about allocating more capital sooner because they feel like they have a really good sense of the manager. In this case, they’re getting probably more information from a lot of their larger asset managers.

So I think it's an important way to think about things. Even if they can't redeem, you know, giving them that information can actually be a really good way to develop the relationship with your larger allocators.

GREGORY: Great. Thank you. And the last question we had was more under compliance and regulatory compliance side of thing and see how this fits into the approach.

Obviously, some of this, like what Matthew discussed already around the risk management process, often, this gets approved by the regulator and this is shared with the regulator on an ongoing basis. But can you tell us a little bit about how compliance fits into this overall project?

MATTHEW: Yeah, absolutely. I mean, obviously, the first point to focus on is your obligations to report to the regulator be it, you know, short selling, for example.

And so as a result of that, what you really need to do is you need to be able to test your reporting functions vigorously to make sure that what you are giving to the regulator is, first of all, accurate and secondly, timely, because we've seen a lot of regulatory fines across the spectrum as a result of incorrect reporting or untimely reporting.

And the best way to counteract that is to test thoroughly. The regulators don't drop these kind of regulations on us, you know, on short notice. There's plenty of time to prepare for this.

Again, it goes into... I think what both Matt and Caroline spoke about earlier is the utilization of your data, understanding the data you're using that you're then giving to said regulator.

So from a post-trade compliance, I think that's very important. Obviously, the pre-trade compliance is making sure that your risk management system is fit for purpose to cover these bases beforehand as well, be that regulatory risk limits, for example. And so, again, it's just understanding and making sure those are in place. Those are thoroughly tested beforehand and then rolled out accordingly.

GREGORY: Great. Thank you.

MATT: I'll jump in here. I guess, again, from a… I'm coming from a particular, yeah, UCITS majority angle. But, you know, the large part of that development of universe of funds is ultimately being driven by demand from investors to over-regulated products, particularly if you're an intermediate, someone else's capital, buying a regulated versus an unregulated funds structure is beneficial.

So there's a significant sort of push from the allocator side. And then clearly, when you're dealing with regulated fund structures, regulatory compliance and risk management are inextricably linked. You know, you can't separate the two. To me, they are just one and the same discipline.

That, to be honest, it's just something that I personally think is going to continue. Even if you think outside of the regulated fund structures, the burden of regulation continues to increase. It has to be linked in and not just lip service. “Our OMS-PMS has got a regulation compliance module, probably is not going to cut it these days particularly with larger advocators.

MATTHEW: Absolutely. I mean, we've definitely seen a larger interaction, especially within Europe, you know, from the likes of the Central Bank of Ireland, for example, in the U.S., who are really pinning down on things like liquidity risk quite heavily. And as a result, you really need to build that into your framework and understand really what the regulators are asking you for.

GREGORY: Great. And thank you for this great question. Okay. Well, thank you very much. Sam, I’ll hand it back to you.

SAM: Thanks, Greg. And thank you very much to our panelists for joining today -- Caroline, Matt, and Matthew -- and to Gregory for moderating. That was extremely informative. I've been sitting here studiously taking notes, I can assure you.

We'll be sending out a recording of the session and a copy of the white paper to everyone who registered, so look out for that. And there's always more to discuss on this topic, right? I'm sure we could have carried on for another hour but unfortunately, we have things to do. So if you have 10 minutes spare, just jump onto the tables. They'll appear soon after the session ends, and you can chat to other risk management professionals on the call. But thank you for joining. And if you'd like to discuss anything further, please get in touch with us, landytech.com or via LinkedIn. We're always happy to talk. And yeah, thanks again to our panelists for their time, and we'll see you on the networking tables.

CAROLINE: Thank you.

GREGORY: Thank you.

MATTHEW: Thank you.

SAM: Thanks, everybody.