Keeping risk in check

Keeping risk in check How BlackRock helps institutional investors to manage risk by Doug Bartholomew Ed Fishwick is co head of the Risk and Quantitative Analysis (RQA) Group. BlackRock is well known for its strong risk management systems and culture. But how does the company translate its risk insight and expertise into services and systems for institutional investors? A guiding tenet of BlackRock s philosophy of risk management is that models and systems should function in support of a broader decisionmaking process that depends first and foremost on the experience and judgment of the portfolio manager and risk manager. Ed Fishwick is co-head of the Risk and Quantitative Analysis (RQA) Group, which plays a major role in developing and enhancing BlackRock s risk management tools. A key element of risk management is judgment and expertise, and in particular understanding why models don t always work, he says. RQA s main focus is understanding risk in portfolios, which is partly heuristic and partly judgmental In other words, although systems are essential to the day-to-day management of portfolio risk, it is the people behind the systems who ultimately keep risk in check. Portfolios are managed by people, and the best way to manage risk is to work hands-on with portfolio managers, wrote Bennett Golub, BlackRock vice chairman and chief risk officer, when announcing the formation of the RQA group. Many institutional investors are familiar with Aladdin and the Green Package. These are sophisticated portfolio analysis and risk reporting services provided by BlackRock Solutions (BRS), which manages the tools, services and data for the company s asset management business and for third-party risk management clients. But not all sponsors have a clear picture of how RQA and BRS while serving different but related functions work together to shape and develop BlackRock s comprehensive risk management solution. How do RQA and BRS differ? BRS creates the models and the technology platform for risk and portfolio management that are used by BlackRock and client organisations to drive better-informed decision-making. RQA s task is to ensure that the risks BlackRock and its portfolios take are well understood, are consistent with what portfolio managers expect and are constantly monitored against those expectations. In other words, RQA advises BlackRock portfolio managers internally as well as the company s asset management clients, including institutional investors, to help them understand the broader risk in their portfolios and ensure that it is commensurate with the level of anticipated returns. Although their functions are different, the two groups work side by side to develop new risk models and to continually challenge and vet existing frameworks and methodologies for BlackRock and other organisations that 18 January 2011

THE GREEN PACKAGE What it is: A suite of comprehensive risk analytics and compliance tools. What it does: Models portfolios, benchmarks, and liabilities and aggregates risk exposures. Additional capabilities: Conducts stress testing showing the impact of various scenarios on portfolios. Why is it called the Green Package? It was originally delivered to portfolio managers every morning on green paper, so it would stand out among the blizzard of paper on their desks. ALADDIN What it is: An enterprise investment and risk management platform. What it does: Combines portfolio administration, risk analysis, trade execution, and operations. Additional capabilities: Enables intra-day reporting with up-to-date risk data on investment portfolios. What does Aladdin stand for? In a naming contest among employees of our first external Aladdin client, the Asset Liability and Debt & Derivative Investment Network won, and Aladdin was born. use its risk and portfolio management systems. If an RQA account manager, in working with a number of clients, realises that institutional investors are hungry for a new predictive risk tool with special functionality, he or she will work with BRS to build it into Aladdin or the Green Package. Typically, RQA risk analysts work with portfolio managers to help them understand both market and portfolio risk. The goal is to ensure that portfolio risks are consistent across mandates, reflect current investment themes within particular strategies and comply with client-specific parameters. RQA helps to create and design the risk analytics that become the core of BRS software tools. RQA s other key responsibility is internal managing BlackRock s company-wide risk using BRS software. For fiduciary management clients, BlackRock acts as a virtual chief investment officer, managing their investment portfolio while harnessing the risk management capabilities of both BRS and RQA. For these very large fiduciary clients, we are using our risk management capabilities to get asset management business, Fishwick says. This is seen as the future of institutional management, which not many other firms can do. It is one of BlackRock s biggest strengths because we have the culture, the systems and models, and the right people. You need all three for effective risk management. How risk is kept in check For many institutional investors, the face of BlackRock s risk management service is BRS. With around 150 clients and 180 ongoing client assignments as of September 2010, BRS serves insurance companies, banks and other financial institutions, pension funds, endowments and asset managers. BRS models more than 8,000 portfolios, performs 180 millionplus option-adjusted calculations per week and serves more than 6,000 institutional investor and other non-blackrock users of the Aladdin portfolio management system. Aladdin and the Green Package are highly configurable and the reports clients receive are tailored to include the risk exposures most relevant and meaningful to a particular client, says Rob Goldstein, head of BRS. Currents 19

Rob Goldstein is head of BlackRock Solutions. While the reports appear customised, they re all based on the highly configurable nature of Aladdin. BRS staff handle the configuration based on discussions with the client or portfolio manager. In addition to configuring the system to the client s needs, BRS staff also work closely with clients to ensure that they understand the implications of risk analytics. There is a difference between someone providing the risk analytics on a report and helping a client understand risk, Goldstein says. A lot of other risk tools are just software. We model complete portfolios as a service and give clients risk results, working with them to help explain the risks in their portfolios. Risk management cornerstone BRS comprehensive suite of risk management and compliance reports, called the Green Package, provides transparency into portfolio risks and exposures across asset classes. BRS models portfolios, calculates analytics, creates reports and performs extensive quality control. Clients typically access Green Package reports via their customised BRS websites. More than 100 organisations, including pension funds, banks and insurance companies, currently use the Green Package. As the cornerstone of the BRS investment management process, the Green Package offers sponsors a wealth of information that can be used to measure, track and evaluate their portfolio risk and exposure. Having a detailed view of their exposures can be a huge advantage for sponsors, enabling their portfolio and risk managers to make smarter decisions. For example, just as the severity of the credit crisis was becoming clear in early 2008, a large Bermudabased reinsurer began using the Green Package. During this volatile period, the Green Package analytics proved to be an extremely timely and valuable addition to our portfolio and risk management capabilities, says a director in the firm s market risk management group. The solutions enabled us to more thoroughly monitor the portfolio throughout the crisis and quantify our decision-making to actively simplify and de-risk the portfolio. Combining risk and portfolio management BRS Aladdin platform combines the risk reporting capabilities of the Green Package with portfolio management, trading and operational processing tools to provide a fully integrated enterprise investment platform. BlackRock, which also depends on Aladdin internally as its centralised platform for managing clients assets, offers the Aladdin service to BRS clients. The ability to move easily from risk analysis to decision support and implementation is, to say the least, a big draw for portfolio managers. Using the Aladdin toolset, clients can: ` ` Calculate trades to rebalance a portfolio relative to a benchmark or to achieve a specific objective ` ` Run pre-trade compliance on orders and send them out for execution ` ` Manage operational processes such as trade confirmation and settlement notification. 20 January 2011

So why choose BlackRock to manage risk? There are plenty of risk management systems out there how is BlackRock s any different or better? There are several reasons, according to Goldstein. For one thing, we are both a user and a provider of our risk management services, and there is no one else who offers tools that they use in support of trillions of dollars of their clients money, he says. Another reason is that a lot of the other risk tools in the marketplace are software, whereas what we do is service. We effectively model the portfolios and give the results back to the client rather than giving them a diskette or a CD and letting them figure out how to model the portfolios with a piece of software. Risk management software typically equates to seemingly endless data challenges. Using BRS service model, clients connect online to access the Green Package and are able to do their risk analysis and reporting by reviewing results rather than having to figure out how to create trustworthy reports themselves. Finally, BRS risk experts work with clients to make sure they understand both the risks embedded in their portfolios and the ways they can manage those risks. We go beyond just giving them a report we help clients understand how to interpret the report and what to do with it, Goldstein says. The bottom line is that risk management is integral to the investment process at BlackRock. To be effective, your risk management has to be at the heart of the firm, Fishwick concludes. At its root, risk management is a qualitative discipline it demands a lot of judgment to work. t IMPACT OF CREDIT CRISIS ON RISK MANAGEMENT In the wake of the credit crisis, many institutional investors have understandably become more risk-aware, with some re-examining both their appetite for risk and how they go about keeping risk in check. For BlackRock, the crisis served as a reminder that models are only models, and the best way to manage risk is to exercise good judgment. Clearly, since the credit crisis we are more aware than ever that models have limits, says Ed Fishwick, co-head of the Risk and Quantitative Analysis (RQA) Group, which plays a major role in developing and enhancing BlackRock s risk management tools. Although BlackRock has not altered its approach to handling risk as a result of the upheaval in the financial markets, Fishwick insists that the crisis spurred a heightened awareness of various risks and their impact. Five years ago, it was clear that liquidity risk was central, but I don t think everyone was aware of how essential it is, he points out. The upshot is that BlackRock s risk management systems are in greater demand than ever. Our clients are looking for help from RQA more now than they were before, Fishwick says. Risk management is what people want it s one of the things they consider when they choose an asset manager. In fact, the crisis served to underscore the need for more not less attention to risk analytics on the part of institutional investors and portfolio managers, says Rob Goldstein, head of BlackRock Solutions. What we learned from the crisis is that you need to not only look at the old numbers you used to look at, but you need to look at even more numbers today in terms of risk analytics, he says. The nature of risk analytics is that you are estimating what would happen to your portfolio if a certain thing happened in the marketplace. One of the primary lessons learned from the crisis is that you need to look at portfolio stress-testing more heavily, you need to evaluate risk more heavily, and you need to look at different types of analytics at a security level. If anything, the crisis reinforced the importance of risk analytics. Currents 21

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