Risk Management: Foundations for a Changing Financial World

CHAPTER 36

FINANCIAL RISK MANAGEMENT IN GLOBAL PORTFOLIOS^aj

R. Charles Tschampion, CFA

Managers deal with financial and investment risk in three general ways: global diversification, management of the strategic asset mix, and active management. The first step in successful risk management is to establish a baseline portfolio to meet the investor’s long-term objectives. Next, take advantage of opportunities for risk management by rebalancing the strategic portfolio and by active asset management. Be aware of the risky bets hidden in certain investment positions. And finally, do not panic; avoid trend following and stick with the strategy.

Two maxims are important in portfolio management. The first is: Investment management is not an art, and it is not a science; it is an engineering endeavor. The second is: Risk can be managed but return cannot. These two maxims lead to the conclusion that the money management business is one of engineering financial or investment risk and re-engineering portfolios. This concept is the thrust of this presentation. The final section of the presentation offers some ideas on why bad things happen to basically good markets.

Both sponsors and managers are under increasing pressure to produce superior results. In other words, based on the second maxim, corporate sponsors and managers are being asked to generate what they cannot manage. U.S. corporations do not want any surprises, and they want as little risk as possible. The challenge in re-engineering ...