Managing The At Risk List

MANAGING YOUR AT RISK LIST

In periods of substantial market volatility frequently managing your client “at risk” list becomes increasingly important. The Tech Wreck and the Great Recession created substantial risks to mandates for investment firms on multiple levels. Today’s environment shares many of the characteristics of those periods and so it is crucial to be on top of your client book and to design strategies to minimize surprises. Private market firms and hedge funds should also look careful at their assumptions for fund raising as it will certainly be impacted.

What is an at risk list? It is a way of staying focused on what clients might be redeeming and why. Done well it describes the factors creating a risk to the account, the probability of this occurring and action plans to mitigate the potential damage. On the new business side of things, its more about adjusting probabilities and funding levels and being realistic about the impact of market conditions on fund raising.

The majority of the time, the risk factors are specific to the client, to the investment firm or the strategy. But in environments like this its macro factors that can dramatically increase risks to mandates and fund raising.

At capital pools, changes in board make up, CIO’s or critical staff, major changes in strategy (de risking, going passive, etc) and potential mergers or acquisitions, are all factors that would trigger an at risk classification for a client even if with a low probability.

Personnel turnover, poor performance, negative headlines, strategy migration and poor client service are all factors that can create risks based on the investment manager itself. The type of strategy being managed can also come under scrutiny. For example, during the 2000’s billions were awarded to GTAA mandates only to be substantially reduced as hedge fund portfolios got built out and managers in the GTAA programs underperformed.

Of more concern today are “leverage” and imbalances in portfolios created by the sharp drop in asset prices. The typical fund may end the year down 20% or more. A fund with a fully committed and invested private asset portfolio targeting 20% of assets, now sees that number closer to 25%. At the end of the 2008/2009 fiscal year, a number of prominent endowments had private investments and commitments well in excess of 100% of assets. This “leverage” was in part caused by negative returns in the mid 30’s. While portfolios returns have not fallen as dramatically as during the financial crisis, the knock on effects will be similar even if more muted. Investors can either approve increases in allocations, even it temporarily, slow commitments to allow distributions to reduce exposure or patiently wait for the markets to reprice and rebalance.

While there have not been the market disruptions that occurred during the Great Recession and the banking industry seems healthy there have been ripples in the water. Archegos, the UK gilt issues and FTX are examples of disruptions caused by the current tightening cycle. While it all seems manageable now, so much depends on the path of interest rates.

What other adjustments to allocations will occur due to unforeseen market conditions? How will this impact client portfolios, their cash needs and the ability to maintain mandates and commitment targets at current levels?

Managing these potential outcomes is what a robust at risk list and management strategy are for. In environments like this it is as important to review the at risk list frequently as it is to discuss new business development.

James B. White, CFA Managing Director