Generalized considerations about equity and mean reversion have been institutionalized with the creation of glide path or "life-cycle" funds. but the authors of a new EDHEC paper contend that the glide paths defined by these funds don't represent the optimal approach to portfolio allocation.

Vikas Shah discusses fixed-income risk management with Kevin Anderson, SSgA.

In Jack Schwager's view, the hedge fund industry as a whole is not a "mirage" at all. But relying on the past track record of specific funds or strategies: that is a dangerous reliance upon a mirage. Perhaps suggest that Grandma should put her nest egg in a diversified fund of funds.

As David Belmont reminds us in his new paper for the Commonfund Institute, in the U.S. there are limits on the practrice of rehypothecation. A broker can only reuse in this way assets of up to 140 percent of the value of the client's liability to said broker. Intriguingly, in the U.K. there are no such statutory limits.

SEI put together a 10-part guide as an effective risk management tool to set the foundation for operational excellence. Below are excerpts from chapters nine and ten, now available for download at www.seic.com/OpsSurvivalGuide.

The notion of a flight to safety has never before sounded so paradoxical. The impending fiscal cliff illustrates the unsustainable fiscal position of the U.S. Treasury, and the uncertainties this creates may generate a flight to the presumed safety of ... U.S. Treasuries.

Operational risk within investment management firms can stem from many sources. Firms also have varying tolerance levels for accepting or handling such risk. SEI believes virtually every firm can benefit from taking a fresh look at common areas of risk and consider the variety of relatively straightforward risk management measures that can readily be deployed. [...]

Operational risk within investment management firms can stem from many sources. Firms also have varying tolerance levels for accepting or handling such risk.

It is not simply that VaR as classically formulated presumes a Bell curve with the very narrow tails that implies (although that is one of Stephen Rahl's criticisms in his contribution to this book, it is by now pretty much everybody's criticism). Other problems are: that VaR treats the past as the guarantor of the future, and that it arbitrarily identifies variance with risk.

Operational risk within investment management firms can stem from many sources. Firms also have varying tolerance levels for accepting or handling such risk.

Institutional investors and consultants are by now very sensitive to the fact of fat tail risk, and are no longer confident that diversification among traditional asset classes is a sufficient approach to the management of this risk. Portfolio changes now underway reflect this heightened sensitivity.

A dollar invested in the PutWrite Index in 1986 would have been worth $12.53 in January 2011. That represents annualized growth of 10.4 percent. ACG concluded that such option writing strategy-based indexes “could appeal to investors who are concerned about low interest rates, increased volatility, illiquid investments, or sluggish stock market returns.”

The issue of restitution for loss has been very much on the midns of the asset management industry over the last four years. As EDHEC observes in its new report on non-financial risks, “The collapse of Lehman not only [showed] the world that a systemically large institution could fail; it put … the question of international cooperation and rules harmonisation on centre stage. Restitution may be rendered impossible, at least under reasonable delays, in extreme cases such as the default of an institution – reputable as it might have been.”

Any quantitative strategy is susceptible to being reduced to an index, and along with this, to transparency and routine. Once this happens, that "alpha" becomes "beta," and the 2 + 20 fees are no longer available. A manager in search of alpha will have to move beyond that strategy, peeling away that layer of the onion and going to a deeper, not-yet-indexable, strategy.

AllAboutAlpha discusses alpha, risk and constraints with Axioma CEO Dr. Sebastián Ceria.

Traditionally, the endowment model has involved holding illiquid assets, and benefitting from the premiums that markets pay institutions with a tolerance for illiquidity. Further, this self-image of endowments as buy-and-hold institutions leads to a de-emphasis of risk management, in the expectation that near term zigs and zags will level out nicely if given enough time. Mark Schmid and Que Nguyen, both of the University of Chicago, break with this model in a recent paper. They say, “While we continue to pursue strong returns, we must do so without taking on excessive risk to the University."

The top four risks facing pension fund sponsors, in the order of importance assigned to them by those sponsors, are: underfunding of liabilities; asset & liability mismatch; asset allocation; meeting return goals. These are the same four goals that were top rated last year. “The year-over-year consistency in the top four risk factors … is not entirely surprising” the study authors say. The consultancy and actuarial firm Milliman lowered the average discount rate from 4.53 percent in November to 4.25 percent in December 2011.

From Lynne Feldman, Director of Marketing at the CAIA Association: Ken Shoji, Chief Operating Officer, GSB Podium Advisors LLC, discusses risk management in hedge funds, including measurement, analysis, and reporting; liquidity management; risk budgeting and allocation; and tail risk strategies . Mr. Shoji spoke with Wendy L. Coleman, CAIA, CFA, FRM, Senior Advisor to the CAIA [...]

Comparing the different editions of the Axioma Quarterly Risk Review for 4th Quarter 2011 leaves some fascinating insights. For example, it is becoming more difficult over time, in much of the world, for investors to create significant diversification within the (domestic) equity portion of their portfolio, because the correlations of stock pairs have been increasing.

The Global Association of Risk Professionals has surveyed risk managers, analysts and academics to get a sense of the implications of the demise of MF Global Holdings for the role of risk managers. Its findings add to a growing sense that the firm’s last chief executive, Jon Corzine, a former New Jersey Governor and U.S. Senator, was an edge-dwelling trader at heart, eager (as Dealbook put it in an analysis in December) to play a “hands-on role in the firm’s high-stakes risk-taking;” indeed, a man enmeshed in a “romance with risk.”

The right question is not what were they thinking, but what were they feeling? Get organized about detailing what feelings are being acted out and you’ve landed on the missing link in risk prediction.