Changes in Franklin Templeton Investment's approach to risk highlight the influence of risk managers. Nicholas Pratt talks to Wylie Tollette.
Wylie Tollette, director of Performance Analysis and Investment Risk department at Franklin Templeton, heads up a team of 75 people operating in 14 countries. The department was set up in 2001 with just a handful of staff. By the time Tollette joined the firm's risk department in 2004, there were more than 40 with the majority employed on the performance attribution side rather than investment risk management.
Market risk is still the primary focus for Tollette’s team. However, changes in the financial markets in the past five years have seen the team’s remit expand to cover other areas of risk. Right now, there is a focus on currency risk, especially in Europe, given the volatility in the eurozone. But a key change was made in 2007 when Franklin Templeton set up a credit counterparty team. “We had always had that function but following the failure of a number of Bear Stearns hedge funds, we needed to get a better handle on the counterparties we had,” says Tollette.
At the height of the financial crisis, the counterparty team held hourly meetings. The frequency of meetings has relented but the team’s responsibilities have grown.
“We now seek full collateralisation of all of our OTC [over-the-counter] derivatives, which has been very successful in reducing our daily exposure. We also publish an internal list of all counterparties, the banks we consider worthy of trading with and the trading limits that should be used across the bank for each counterparty.”
Such a move shows how the influence of risk managers has grown in the post-crisis era to the point where they can set trading conditions for their front-office colleagues and know they will be adhered to.
“Our portfolio managers have been very much on board. There may have been some issues initially but it just took a few more bank failures for everyone to realise the importance of counterparty creditworthiness.”
What also helped was the move to deploy risk managers to work alongside portfolio managers. This not only gives the risk department more credibility with the portfolio managers, it also helps fund managers to understand the reports that the risk managers produce.
Demystifying the complexity of risk management and performance attribution is the primary role of Tollette’s team. “We have largely relied on vendor tools for the underlying information. Building and maintaining a co-variance matrix (a source of historical data that is the basis for any performance or risk reporting system) is a huge task. But the output that these systems produce can be very difficult to understand for anyone who is not a risk manager. So we customise that output and make it understandable and concise enough for client use.”
This transposition will continue to be one of the main challenges for Tollette’s team – the other concerns data input. “We’ve set up a complex instruments review committee to look at all new instruments and if we have the systems to support them. If not, we won’t approve them for use.”
Again this shows how the risk function has been elevated to a more influential role within the firm. However, a final challenge for Tollette and his team is stressing to underlying clients and investors that there is a limit to the use of these risk statistics.
“We saw this problem before the financial crisis when people were taking Var [value at risk] numbers and making them more than what they were. There is no one risk statistic that is the be-all and end-all. You have to look at risk from a variety of factors and also remember that risk management is not necessarily there to prevent losses but to prevent surprises.”
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