Expert on risk management explains how he helps the pros
Capital markets are often influenced not only by the decisions of big institutional investors but also by the risk management systems and programs they use. One of the companies developing such systems is APT, with offices in the world’s largest financial centers, hundreds of clients that include portfolio management firms, pension and hedge funds, and business consultancies. Its analyses of the risk-performance relationship in mutual funds are published in nine newspapers, including the Financial Times. Director of APT Europe Jamie Ridyard was in Athens recently and spoke to Kathimerini. Tell us a few things about APT. APT provides the world’s top investment organizations with specialized risk management instruments for diagnosis, analysis and reduction of risk in portfolios that include stocks, bonds and other products. Is this not a job for which investors already pay portfolio managers? It is, but it has been proved that a good risk management model does the job better than any manager. Besides, if this part of the job is undertaken by a computer program, this leaves more time to select the right investments. Every investment includes a combination of risk and return; if we want a higher return, we must accept a higher risk. Our system manages the risk segment; the return segment can only be managed by a portfolio manager, who is responsible for making the right choices. In other words, a manager makes a list with the best investments and APT helps him combine them in a portfolio in the most profitable way? Exactly. Until now, managers had no reliable assistance in deciding what part of their capital to invest in each product. Some invest in companies they like, without knowing how their total risk is affected. Others choose according to capitalization or invest equally in all companies they select. But with a risk management model, risk can be substantially reduced without loss of performance. What do you mean by reduction? Is the market not risky by nature? Some investors prefer a combination of shares that offer high returns but whose price fluctuates greatly. Others, more conservative, are willing to accept lower returns, and are happy to know that their capital will have about the same value tomorrow. This fluctuation in the value of a portfolio, from day to day, from month to month, is called variability and is the most common way of measuring risk. How does altering the percentages of investment in the same shares reduce variability? I’ll give you an example. Let us suppose we can buy two shares. They both have the same expected return. One has twice as great a variability as the other. They are in different sectors, and let’s suppose there is no relation between the fluctuations of their prices. We shall limit ourselves to five options: 100 percent in one share, 100 percent in the other, 50 percent in each, and two-thirds in one and one-third in the other. No matter which option we choose, the expected return will be the same. However, the right answer is to invest two-thirds of our money in the share with less variability, as this will involve the lowest risk among the five options. In this hypothetical model, is it relatively easy to choose. But in a portfolio with 10, 20 or 100 shares it is practically impossible to find the right allocation without a risk management model. So, a proper risk management system finds the right combinations? It not only does that, it is one of its most important functions. It calculates the size of the risk and shows where it stems from, that is, whether it is a sectoral, financial or currency risk, and so on. The system looks both to the past and future. It analyzes the performance of a portfolio to date and gives an indication as to what can be expected from now on. The analysis, of course, is easier than forecasting, and so, everyone’s interest is focused on the quality of forecasting. What can our readers gain by reading this interview? Good question. They can ask those who manage their money (mutual-fund, insurance-company or pension-plan managers) what safety valves they have to guarantee that if things do not go well, they will not lose a large part of their money – how they manage market risk. Also, if they invest in European mutual funds, they can consult APT’s assessment of Risk-Adjusted Performance (RAP) free on the webpage of the Financial Times (http://funds.ft. com/funds). We are likely to have similar data on Greek funds soon, as part of our expansion throughout Europe. Your readers may obtain more information at www.apt.com.
