The role and modernisation of risk management in discretionary multi-asset investing

Introduction

The importance of risk management has become ever more pronounced in the aftermath of the Global Financial Crisis (GFC). In an effort to spur their economies out of recession and raise risk assets out of a lost decade of returns, developed central banks pulled interest rates to historical lows and, thereby, extended the secular bull market in bonds.

In this post-GFC world, investors have broadened their investment universe to find alternative sources of both return and risk mitigation. This has led to a modernisation of risk management that is more suitable to an investment approach that goes beyond a traditional stock and bond portfolio.

The focus of this paper is to explore the role of quantitative analysis within the realm of discretionary portfolio management, where humans – rather than models – ultimately make capital allocation decisions, specifically within a multi-asset investment framework. In this type of qualitative approach, risk management is necessary for robust portfolio construction. The opportunity set for multiasset portfolios crosses asset classes, geographies, sectors and currencies. Hence, there are many relationships that should be considered by portfolio managers to take risks efficiently.

Furthermore, aiming to deliver a positive, absolute return in all market conditions shifts the role of risk management from a policing and ex-post analysis function versus a benchmark to one of active involvement in the portfolio construction process. In our view, the analysis and dialogue regarding investment risk is optimal when a risk management expert sits within the investment team and among the portfolio managers to ensure constant and iterative interaction. In this paper, we explore the tools and considerations that comprise our on-desk risk management process, which we believe is essential for enabling a portfolio management team to thoughtfully take risk to garner returns.