A SURVIVAL GUIDE
FOR INVESTMENT MANAGEMENT FIRMS
AND HEDGE FUNDS
What This Book Covers
Who Should Read It
Advance Praise
About the Authors
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More than ever before, institutional investors and their consultants are probing investment management firms’ risk management policies and procedures. Beyond market, credit and liquidity risk, their concern extends to investment managers’ back- and middle-office functions. For example, investors and consultants are asking:
• Is the firm managed and staffed by qualified people?
• Are workflows properly documented and consistently followed?
• Are employees cross-trained to handle one another’s jobs?
• Does the firm keep track of collateral in the hands of prime brokers?
• How does the firm plan ahead for changes in the regulatory and competitive environment?
In the aftermath of the global financial crisis, clients and prospects want to know the answers to these and many other questions. And they will not entrust assets to organizations whose day-to-day operations are chaotic or whose long-term business prospects are doubtful.
“In worst-case scenarios, an investment firm’s failure to identify and mitigate operational risk can result in significant direct costs and a devastating loss of reputation,” write Holly H. Miller and Philip Lawton. “It may take years to reassure investors, regulators and trading partners that the firm is well-managed.” Internationally known as dynamic speakers and engaging writers, the authors of The Top Ten Operational Risks draw upon their extensive practical experience to offer clear, compelling and—above all—useful advice about how to recognize and lessen the risk of loss due to inadequate internal processes, people and systems or external events.
Starting with complacency on the part of senior management, each of this book’s central chapters addresses one of the ways in which investment management firms may be exposed to unwelcome surprises. There are succinct, readable essays on staffing, training and the special attention due hand-offs among individuals, teams, systems and external service providers. Other chapters focus on technology, workflows and aspects of the segregation of duties that are especially significant in the investment management industry, such as observing the distinction between the firm and the funds it manages. The authors additionally bring their experience to bear on reconciliation gaps, the importance of knowing the firm’s counterparties and the regulatory regimes to which they are answerable, and the challenges of effective strategic planning in a rapidly changing marketplace.
At investment management firms and hedge funds, C-level executives and middle managers in sales and marketing, client and consultant relations, compliance, human resources and internal audit will find The Top Ten Operational Risks compelling. Their colleagues in risk management and investment operations will find it indispensable. As Milton Ezrati writes in the foreword, “The investment of an hour or two will offer managers numerous ways to improve their firm and their client service and, critically, a means to guard against rather large, unexpected expenses.” Securities regulators, institutional investors, family offices and high-net-worth investors will also gain valuable insight into hidden risks in the global investment management industry.
“Investment operations can be complex, and yet the back office is often overlooked. The authors explain the risks and provide clear guidance for best practices.”
—Bill Bogle, Partner and Chief Compliance Officer, NEPC LLC
“In the wake of the global financial crisis, asset management firms are paying more attention, not only to investment risk management, but also to oversight of the operational risks that come with day-to-day activities like portfolio valuation. Stone House Consulting’s book contains timely and thought-provoking essays of current interest to operations and technology managers.”
—Bruce J. Feibel, CFA, Managing Director, BNY Mellon
“Readers will appreciate the pragmatic, forward-looking approach adopted in this book. When discussing issues like automation, outsourcing or accounting that practitioners encounter in their daily work, the authors’ aim is always to show how risk tools may prevent problems from occurring.”
—Jacques Gagné, CFA, CIPM, FSA, asset and risk manager, Québec
“Anyone working in a managerial or supervisory capacity in the investment industry would do well to secure a copy of Stone House Consulting’s book on operational risk. The writing is concise, the content is relevant, and the guidance is realistic. You will have immediate take-away value.”
—Sandra Hahn-Colbert, CFA, Managing Director and Director, Performance, Risk & Operations, O’Shaughnessy Asset Management
“All the hard work of finding good investment ideas can be undermined by not having appropriate operational support. This collection of essays goes a long way toward identifying potential pitfalls and offering practical solutions for avoiding them.”
—Todd P. Lowe, CFA, President, Parthenon LLC
“The Top Ten Operational Risks is a must-read for Chief Compliance Officers. Substitute ‘compliance’ for ‘operations’ and you have an outline of how build a proactive compliance program designed to consistently and effectively prevent, detect, and correct compliance problems, while efficiently utilizing your firm’s resources.”
—Bart McDonald, Executive Vice President and Chief Operating Officer, Renaissance Regulatory Services, Inc.
“Here's a checklist of sound operational practices—written in plain English. Use it!”
—Alan M. Meder, CFA, Chief Risk Officer, Duff & Phelps Investment Management Co.
“I began my career as an equity assistant and learned the business from the bottom up; for those who were privileged to start out at the top of the process as portfolio managers, these papers should be required reading. The Top Ten Operational Risks is a book I want in my office, yesterday, and I’ll get additional copies for other members of the firm.”
—Janet T. Miller, CFA, Partner, Rowland & Company
“When many investors think about risk, they worry that the assets they’ve bought could go down in value. But that’s a risk with an upside—you have to take that risk to make money. Investors must work even more carefully to avoid taking risks that have no upside, which Holly Miller and Philip Lawton categorize as ‘operational risks.’ Far more firms have been sunk by easily avoidable operational risks than by fluctuations in asset values. These sinkings are a completely unnecessary tragedy. Read Ms. Miller and Mr. Lawton’s volume to learn how to avoid them.”
—Laurence B. Siegel, Research Director, The Research Foundation of CFA Institute
“Research shows that operational risk is more significant than financial risk in explaining fund failure. This book will tell you how to keep the operational gears grit-free and turning smoothly.”
—Rodney N. Sullivan, CFA, Editor of the Financial Analysts Journal and Head of Publications at CFA Institute
"I really like the authors’ straightforward, no-nonsense approach to dealing with operational risks. This is a book that I will share with the leaders of our organization."
—Cinda Whitten, CIPM, Director - Investment Operations, Principal Global Investors
About the Authors
Holly H. Miller is the founding partner of Stone House Consulting, LLC, providing strategic, operational and IT consulting services to investment managers and hedge funds. Prior to founding Stone House Consulting, she was Chief Operating Officer at M.D. Sass, managing $17 billion in hedge funds, private equity funds, traditional separate accounts and wrap-fee accounts across 18 investment strategies and 15 investment management firms. During her 30-year career to date, Ms. Miller was East Coast Region Manager for Citisoft, Inc. where her clients included several of the world’s largest asset managers. She has also managed operations teams for Bank Julius Baer, J.&W. Seligman and Citigroup. Ms. Miller is a recognized expert in middle- and back-office outsourcing with an exceptional understanding of the operational and IT challenges faced by the industry and a proven track record of designing and implementing large, enterprise-wide change initiatives. She is a popular speaker at investment industry conferences and publishes regularly in trade publications and at http:// articles.stonehouseconsulting.com. Ms. Miller lives in a 325-year-old stone house in Thornton, PA with her Labrador retrievers, Cromwell and Essex.
Philip Lawton, CFA, CMA, CIPM, joined Stone House Consulting, LLC in 2010 as a partner. Mr. Lawton was the founding head of the Certificate in Investment Performance Measurement (CIPM®) program at CFA Institute. His previous experience includes working as an investment professional at State Street Investment Analytics, Deutsche Bank, Citibank and The Travelers and as a corporate cash manager at Aetna Life & Casualty. Mr. Lawton earned a doctorate in philosophy in the French-speaking section of The Catholic University of Louvain, Belgium, and an MBA degree at Northeastern University. His books and articles in philosophy have been published by Harper & Row, Philosophy Today, Het Tijdschrift voor Filosofie, Philosophy Research Archives, University Press of America, Philosophy & Theology, and International Studies in the Philosophy of Science. Mr. Lawton is also the co-editor of Investment Performance Measurement: Evaluating and Presenting Results (Wiley, 2009) and the author or co-author of articles published by CFA Institute, Performance Measurement and Client Reporting Review and The Journal of Wealth Management. He lives in Keswick, VA with his wife, Dena Lange, and their dog, Nora.