The Managing vs. Marketing of Risk


There’s something in the Santa Barbara water (or wine) that produces some extremely thoughtful investors/writers. Some of you already know that I’m a fan of Eric Peters of Weekend Notes (who resides in Santa Barbara). A friend recently told me about Stephen Duneier of Bija Capital Management (another Santa Barbara resident) who also has been writing thought provoking letters. Below are excerpts from a piece written a few weeks ago on risk management, titled “The Managing vs. Marketing of Risk.” For those of you who appreciate differentiated opinions, it’s a worthwhile read. Risk

“ 'You can take risk. Just don't lose money.' - A Former Boss

Risk management seems like a simple endeavor. It’s not. It requires a deep understanding of what risk is and how it can be managed. Some think that simply being strong is the answer. It’s not. Many think of risk as something you deal with after the fact, and it shows in their pitch. “I will force positions to be shut down.” “I will step in and close positions myself.” “We will cut risk...” All of these statements reflect a reactive risk management process. While they sound tough and disciplined, they are really just impulsive behaviors attempting to clean up impulsive behaviors, after the damage has already been inflicted. Fact is, the biggest hedge fund disasters don’t occur when funds are doing poorly. They come about when they are doing well, and risk management has been sidelined. That’s why every loss and every gain attracts my interest in exactly the same way, for the most effective risk management is both proactive and consistent execution.”

“The speed bump is a generally accepted risk management tool. Essentially it serves as a line in the sand which triggers a specific reaction. As an example, if a portfolio manager is down 5% from the high water mark (HWM; peak profit), then her risk is halved. If it happens again, risk is halved again, and so on. It's one of those things that sound good in a marketing presentation, allowing a fund manager to masquerade as a disciplined risk manager. The problem is that its mere existence creates an impediment to thinking deeper about and implementing more effective, proactive risk management procedures. Worse yet, speed bumps ultimately serve two distinct purposes. They reduce the returns of a good investment manager and they extend the life of a poor one. The better the manager, the more dramatic the negative impact, and vice-versa…in every case where the PM is a positive performer, your returns will be better without a speed bump. What about the poor performer? Simply stated, you should fire him.”