Spirit Versus Letter

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

The Canadian financial industry made it through the economic crisis relatively unscathed.  In fact it was seen as a model for other countries to follow.  Lots of commentaries were written about the strength of the Canadian banking system and views were given on the specific policies that paved the way for Canadian banks to look so good while banks from other countries had their issues.

 

I personally believe that the policies in Canada were nothing special.  However there is one concept in Canada that was, and is, absolutely key.  That concept is having regulation that is based on spirit of the law versus letter of the law.  That is the fundamental difference between risk success and risk failure.

 

The question to ask yourself is whether or not the risk policies in your firm are written so that they will be followed in “spirit” or in “letter”.  The more rigid, extensive, explicit (etc.etc.) the risk policy manual is, the more likely it is to be followed to the “letter”.  What is needed is a policy that is written with the flexibility and the understanding that it should be followed to the “spirit”.  Two very different concepts.  

 

Note:  Today makes the 100th blog from RSD Solutions!  On behalf of RSD we wish to thank you for your support and reads and hope that our blogs have given you pause for thoughts on risk or perhaps the odd chuckle.  We look forward to continuing our blogs and your future continued support.

 

Paradigm Shift: Value investing comes to commodities

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

 

Value investing as defined by Investopedia is a “strategy of selecting stocks that trade for less than their intrinsic values.”  In my years with brokerage firms in the England and Canada, it was very rare that commodity stocks were ever viewed as value type investments as their prices tended to be asset bubble driven.  But I have argued in the past that while commodity prices may fluctuate in the near term, in the long term the trend is up and at a rate faster than inflation.  Joining the “choir” of this thought is much-admired value investor Jeremy Grantham; chairman of global asset manager GMO LLC a firm that manages more than $100-billion (U.S.).  Mr. Grantham sites the usual reasons like increased world wealth (thanks Ben B.) but what seems to be the tipping point for Mr. Grantham is the fact that it took 100 years for the inflation adjusted price of commodities to fall 70% and only 8 years to wipe out those savings.  Mr. Grantham now sees value in investing in commodities.

 

So what does this mean?  To me it indicates that the natural resource countries, especially those that can produce commodities from below and above the surface are in for solid economic growth and currency appreciation likely for years to come.  For commodity users and end sellers, hedging becomes more important to manage potentially highly variable cash flows.  This trend is a now a reality so has your risk strategy adjusted?

 

 

For more on Mr. Grantham’s views on value investing in the commodity sector click on this Globe and Mail link:

http://tinyurl.com/3rpgnmm

Revisiting Definitions

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

Early in this blog series several years ago I wrote a lot about defining risk.  My definition of risk was (and still is) that risk is the possibility that bad or good things may happen.  Not everyone agrees with my “two-sided” definition of risk, but I believe not only that it is mathematically accurate (are you using semi-variance or variance in your risk calculations – be honest) but also conceptually accurate. 

Perhaps the best reason to adopt this two-sided definition of risk is the need for the risk management department to be seen as a valuable strategic function within the firm.  If the definition of risk is focused only on the downside, then the risk function is limiting themselves to being the “Department of NO!”, and a wonderful opportunity to show the true value of risk management techniques is wasted.  That is a terrible downside risk to take.

Rick Nason speaking at Professional Risk Managers International Association’s Chicago meeting

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

On May 2, Rick Nason (Partner, RSD Solutions) has been invited to speak at the Chicago meeting of PRMIA – a globally recognized and highly esteemed association in the field of risk management.  Rick's talk, “Have we lost the plot?” will look at financial risk management and how traditional risk management by algorithms has made the Street and others lose sight of the plot – or the greater story of the markets.  Rick will propose a more flexible and holistic way of thinking that is centered on the principles of emergent systems and complexity theory (see http://tinyurl.com/3bpdmr5). 

We at RSD are delighted that Rick has been recognized by PRMIA for his contributions to the area of risk thought and management and providing him with this opportunity to speak. 

 

For more information on Rick’s talk (free to PRMIA members and $10 to non-members) at PRIMA’s Chicago event, click on the link:

http://www.prmia.org/events/view_events.php?eventID=4450

Key Risks and Challenges for Maintaining Global Financial Stability

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

The IMF released its latest semi-annual Global Financial Stability Report (GFSR) with emphasis on providing a more permanent fix to causes of the financial crisis.  The GSFR made three observations: 

1.      financial stability was improving, but risks remain elevated;
2.      the advanced countries need to tackle rising debt levels and weak balance sheets; and
3.      for emerging markets to guard against overheating and financial imbalances. 

The report provides a roadmap for policymakers to focus their work and reduce the vulnerability to future financial shocks.  Currently, policymakers need to shift their focus from the symptoms of the financial crisis and towards measures to treat the underlying causes.  This includes:  advanced countries addressing high government debt levels and strengthening private and public sector balance sheets.  Secondly, bank’s clean up their balance sheets, increase their capital buffers and write down distressed mortgage loans and restructure existing ones as needed.  Lastly, emerging markets must address potential overheating driven by capital inflows, narrowing output gaps and rising inflation expectations. 

In addition, the GSFR specifically addressed:  the lack of a “credible strategy” in the US to stabilize public debt levels, the market’s favorable reaction to Spanish policymaker’s efforts to reduce financial vulnerabilities.  The IMF noted the US was the only major advanced country, with a rising budget deficit, when the economy was growing fast enough to stabilize or reduce borrowing.  The IMF noted that Spanish officials had taken tougher measures on banking and fiscal reforms that helped to distinguish them from their more troubled neighbors.  As a result of this action, credit default swaps (CDS) spreads have declined. 

 

To obtain a copy of the IMF’s recent Global Financial Stability Report click on the link:

http://tinyurl.com/3fq5jxe

Red Rover. Red Rover. We calllll,… the Risk Manager over

by Michael Arbow, MBA

Partner, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com

 

A few months ago, I wrote a blog about the closing of toboggan hills as a way that towns in the US were attempting to reduce their risk exposure.  Well it seems that some government officials in New York state want to reduce their risk exposure in the summer as well.  The target this time is summer day camp games such as Red Rover (a game I played endlessly growing up in Toronto), kickball and of course the most dangerous – tag.  Unlike the toboggan ban, cooler (?) heads have prevailed and New York state’s children will still be allowed to get fit, learn strategy and share laughs while playing the aforementioned summer games. 

Perhaps what the State Sen. Patricia Ritchie of Watertown may have unconsciously realized is a phenomenon in risk management we call risk homeostasis: that is, by reducing risk you actually increase risk taking behavior.  In this case, with the opportunity to playing tag removed from day camp activities what activity would replace it and could it have been even more risky.  Of course the other problem Sen. Ritchie may have seen is that the cost of reducing playground risk may have been greater than the benefits of happy, out of breath children. 

So the question is, is your organization a victim of risk homeostasis?  In other words have you reduced risk to such a high level of confidence that you are now blind to the new risks that that feeling of safety introduces?

 

For more on risk in the playground click on the link to the NBC story:

http://tinyurl.com/3nu4xvn

Level 5 Risk Management

by Rick Nason, PhD, CFA

Partner, RSD Solutions Inc

www.RSDsolutions.com

info@RSDsolutions.com 

 

Jim Collins in his book “Good to Great” talks about the need for leaders to be humble about their success.  Thinking that you have found the magic formula for success is almost assuredly going to lead to eventual disaster. 

The risk management community often believes it has found the formula or technique for success.  Think about Long Term Capital Management as the poster child for intellectual arrogance.  Enron is also challenging for this role.  Amaranth would likely want to challenge as well.  Almost certainly you can think of an individual in the risk industry who is cocky enough to think that they uniquely understand “The Truth”. 

The events of the recent credit crisis have shaken the risk management industry.  However it remains to be seen if a critical mass of risk managers has seen the relevance of humbleness or Level 5 management.  Brilliance is often stupid.