As we come up to the anniversary of the Lehman Bank failure and the purported start of the current economic debacle it is interesting to see what lessons if any have been learnt in the field of asset management. It appears that in some quarters at least the Emperor’s new clothes remain fashionable.
I was interested to read for example about the survey results in FTfm that investors were far more interested in performance rather than standards. It is a familiar bell with resonance in many areas. It is also interesting to see that little has really changed in due diligence methodology since the events of last year.
As a risk manager meeting clients to describe and reassure them about the risk processes used by my team I was always struck by the approach different types of investors took to the concept of risk management.
The private investor would always appear to focus on performance provided there was no immediate risk to capital. My sessions on risk with private clients were invariably short with most of the time being spent on how investment ideas were generated and where the next generators of performance were going to come from.
The institutional client was quite a different animal – here invariably the sense one often got was that the focus was ‘career risk management’. Would you get fired for having invested with a big name? The chances were that losses emanating from an investment in a big name were far safer from a career perspective provided a few boxes could be safely ticked. Talking of boxes – the miracle black box process still has formidable powers of seduction – particularly when a big name is involved. I remember the justification used to override a concern I had on a regulatory fine on a well known firm that eventually failed – that if that was the standard that was to be applied it would be impossible to employ any of the major brokerage firms as they had all at some stage been fined for regulatory infringements.
Of course in defence of the investor is it ever possible to do an effective due diligence review of a big investment house through the process of a meeting lasting a couple of hours? Is there a realistic practical alternative? There are assumptions made on teams, structures, evaluation processes and competence that are almost impossible to verify through the normal meeting process of due diligence in relation to a large organisation. Yet that is the process that continues to be employed in making an assessment and is clearly insufficient.
When I evaluate risk in an organisation my view is that some of the greatest business and operational risks that exist – lurk in large organisations and the impact of these are almost always significant – Barings, Lehman Brothers, Enron to name a few. The smaller failures that occur at the start of the journey towards disaster are easily disguised and the rot that sets in as a consequence are rarely recognised.
Very small organisations have different risks to contend with – based on keyman issues and lack of infrastructural depth – but these are assessable – because size permits it.
This is not to advocate that only medium sized structures are the safest investment vehicles to place your money with although they recommend themselves to being reviewable, having sufficient infrastructure for questions to be raised about practices that may arise or develop and yet being small enough for small failures to have catastrophic consequences for the business thereby creating incentives to implement better more permanent fixes than the papering over that can occur in much larger organisations.
What I do advocate is that there is an optimum size to an asset manager from a risk management perspective and the big names can create myths of reliability around their existence. Some of the most inconsistent service that I have ever received both as an individual and as a professional have been from large well established organisations.
Due diligence requires more verification work throughout the life of an investment and the status quo on process needs to change. It is in this blind faith in the miracle black box process and the grandeur of the large unverifiable organisation that the myth of the Emperor’s new clothes continues to thrive.
©Jaitly LLP