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Risk is about the ups as well as the downs

Risk is one of the most misunderstood concepts in investing, yet it is one of the most basic. BT Funds Management's risk expert Bev Durston explains what risk is.

Tuesday, April 10th 2001, 12:45PM

When BT Funds Management vice president and head of portfolio risk management Bev Durston talks about risk you should listen.

She's developed a reputation in her field and won acclaim last year when she was named Asia Pacific risk manager of the year (Asset Management) by Hong Kong-based publication AsiaRisk.

Durston was appointed to the position about 18 months ago when BT made a decision that its portfolio managers needed to better understand the positions they held in their portfolio.

She says the creation of a risk manager came about partly because of the size of the organisation. As a fund manager moves from being a boutique house to a mainstream institution it needs to improve its risk management processes.

To most people risk is the possibility of an investment or position tanking.

Durston says risk is symmetrical, that is there is as much upside risk as there is downside.

The problem is that investors tend to focus only on the downside risk.

Her view is that when a fund outperforms, or comes top of the pops then investors should be asking the question, "how did they do it?"

So when you see that so-and-so manager was the top performer in the last quarter you have to ask, before putting money into the fund, how did they do it? Is the process consistent?

"I would worry almost as much about all the upside."

She says often the big hits in terms of returns are not systematic and aren't delivered by process, rather they come from taking on added risk.

Investors, she says, often don't look at how much risk they are taking on when they are doing well.

BT aims for "small, consistent explainable returns" as opposed to big hits.

Part of the BT process is to limit "downside surprises."

She says one of beauties of having the risk management process in place is that the portfolio managers know what the risks of certain positions are, plus the firm can develop mandates for specific risk profiles.

Besides the problems of understanding risk, there is a dearth of information that is made publicly available about risk.

For instance advertising and ratings material often is based on straight performance numbers, rather than risk adjusted returns.

Durston says most large institutions now recognise that risk management is more than a prudent accessory – it should be an integral part of the investment process.

"For large investment managers to remain competitive, they need to institutionalise their investment process through the implementation of risk controls," she says.

"Risk needs to be at the forefront of portfolio construction. The aim is not to limit the creativity or discretion of fund managers, but to make fund managers aware of what risks are being taken, so they can eliminate unintentional risk and ensure that the portfolio is being managed in accordance with a client’s profile.

Her role is to help portfolio managers work out the risk of an individual stock selection before buying the stock.

In many ways she is like the risk police person (not that she would use that title).

To determine the risk she needs to consider the relationships between sectors, countries and stocks, and the correlation these factors have with macro or structural shocks, means it is very difficult for any individual fund manager to be fully aware of the risks inherent in their portfolio – especially given the speed with which financial market move.

For instance if a manager was considering a US tech stock the risks which would need to be assessed would include (but not be limited to) country, sector, smaller cap companies. Those then have to be incorporated into the overall portfolio position.

Durston says a lot of her role is measuring and monitoring what's going on within portfolios and providing internal consulting resource for managers

She is trying to enhance a portfolio's risk and "eliminate non-intentional risk" to get more return per unit of risk.

She says the impacts of the risk management process will take a while to come through in the numbers.

She says her job is forecasting future risks, as opposed to returns.

How accurate is the process?

"We are closer with risk than we are for dot points with returns," she says.

However, no one can predict the outlier events, or when they may happen.

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