Why Wall Street Ignores Real Risk And Why History Will Repeat Itself
This article was originally published on The Daily Capitalist.
This week I attended and reported from the Milken Institute Global Conference in Beverly Hills. It was an excellent event with top panelists from the financial world.
My last session, and one of the more interesting ones at the conference, was, "New Risk Management Strategies."
The session was described as follows:
The market volatility of the past few years has given the financial services community an urgent new focus on risk management. From the home office to the end product, risk management is having a profound influence on the industry's structure as well as the solutions provided to clients. The institutionalization of risk management is resulting in the application of strategy mitigation tactics across the financial services spectrum. Major firms now look beyond diversification in favor of alternative investments and customized and structured solutions as the preferred tools for managing risk. In this panel, we will discuss how the major providers of wealth advice are not only implementing structural risk management practices at the firm level but also in their clients' portfolios.
The panelists were:
Jim Lenz, Chief Credit and Risk Officer, Wells Fargo Advisors
Jim Lenz is chief credit and risk officer at Wells Fargo Advisors and a member of its Executive Committee. He has held a number of positions in more than 25 years in the banking and capital markets industry.
John Moninger, Executive Vice President, Advisory and Brokerage Consulting Services, LPL Financial
John Moninger is executive vice president of advisory and brokerage consulting services for LPL Financial. He also leads the firm's wealth management services, providing advice and solutions to high-net-worth and ultra-high-net-worth clients.
David Morton, Chief Research Officer and Co-Chief Investment Officer, Foxhall Capital Management
David Morton is chief research officer and co-chief investment officer of Foxhall Capital Management, a global manager that uses exchange-traded funds to create separately managed accounts, mutual funds and variable insurance portfolios. He leads the research team.
Colbert Narcisse, Chief Operating Officer, Global Investment Strategies and Solutions Group, Morgan Stanley Smith Barney
Colbert Narcisse is a managing director and the chief operating officer of the Global Investment Strategy & Client Solutions Division at Morgan Stanley Smith Barney. Narcisse is responsible for asset manager relationships, business risk, marketing and strategic planning and analysis.
Moderator: Jon Najarian, Co-Founder, optionMonster.com (brother and partner of Pete Najarian, star of "Fast Money.")
I found the panel's approach to the subject to be disappointing; I was thinking I had walked into the wrong panel.In a post-2008 Black Swan world they, in my opinion, have done nothing to deal with investment risk, especially the kind of systemic investment risk that characterized the current bust. What they have done is to better protect themselves from risk (lawsuits).
I do not mean to characterize these impressive men as dullards. Far from it. As you can see they have all had illustrious careers in the financial world. That they have survived to 2011 is evidence of their ability. But they are risk experts and have responsibility for risk management in their firms. Other than Mr. Morton, none of them are analysts. None of them are economists. That is, they are oriented toward operations and sales. Many of them are multi-taskers and risk management is one of their functions. Most of their discussion related to the retail level of the investment business.
If I can summarize their improved risk management strategy, it would be as follows:
They employ investment strategies that are more tailored to specific client needs. They are more "anticipatory" of clients goals. Beyond diversification, they offer a broader range of investments including alternative investments, such as commodities and emerging markets. There is more focus on macro and world events in making investment decisions. This allows clients to have exposure to a broader range of markets and products. They are much more careful with the selection and due diligence investigation of products. Compensation of salespeople is less short-term based, focusing on a longer term relationship with the clients. They do a lot more training of their salespeople for products they sell.
That's about it. To be fair, I am probably oversimplifying things. If you wish to see the entire program, go here.
I didn't hear the word "Black Swan," but I did hear "Category (Sigma) 7" from one panelist which tells me he was still involved in pre-BLack Swan "Oldthink." I also didn't hear about challenging the analytical models still used despite their repeated failure (Efficient Market Theory, Cap M, Modern Portfolio Theory, Gaussian models, etc.).
At the end they opened it up to questions from the smallish audience and I was able to ask a question.
My question was, "I wish to play the Devil's Advocate and ask you a rather pointed question. [Some joking back and forth here.] If you had employed these new risk strategies before 2008, how do you think you would have come out?"
Two panelists took a crack at it. Here is their answer. This video was taken by me with my little hand-held Flipcam, so please bear with me. The first speaker is John Moninger of LPL. The second speaker is Colbert Narcisse of Morgan Stanley. It's bumpy at first but gets better. Play it at 720 and turn up the volume a bit. If you wish to see their video, see the above link and go to minute 66.
"We now know what to do." "Risk [management] in wealth management has always been very rigorous. If you look at litigation expense that number has gone down significantly between 2000 and 2008."
What they are saying is that they are doing a better job of limiting their risk/cost from customer claims, but they are doing little about systemic risk to protect their clients. I was under the impression that they were going to talk about the risk/exposure to their clients' wealth. These fellows are looking at it from the other side of the mirror: how can we effect strategies that limit our risk exposure to customers' claims. Now you would think that the best way to manage risk would be to do a better job of managing their customers' wealth. While they all say they do that, they aren't doing things much differently than pre-2008.
I am not sure litigation costs are a good measure of risk. A better measure would be how many customers bailed out of the stock market and didn't come back. It is no secret that the stock market customer base shrank substantially after the Crash. One panelist noted with some distaste that customers act on fear "regardless of the facts." Very true. But the fearful man might be acting quite rationally from his perspective. Bad outcomes tend to make investors gun shy.
One may ask why they aren't doing more to deal with systemic investment risk and the truth is that they don't know how to do that and therefore they focus on selling a broad range of products because ... that is how they make money. So let's put things in perspective. The retail guys are in the business of selling products. If they don't do that, they don't eat (I sold stock for two years). The salespeople's job is to sell what the company tells them to sell. I talked to a few of these guys at the conference and they can quite easily tell you the reasons why the market will do this or that, based on their firm's talking points. They were wrong about most things. But they meant well.
It means that for the wire houses, they are back to work as usual, selling product. They have tightened up their respective ships somewhat, but they are all looking at the world from inside the same box. But, it's still sell or die. It should be perform or die. Well, actually, the market does that for them doesn't it.
The more things change, the more they remain the same. And that means they will do the same things all over again.