As the departmental head of one of Asia’s biggest investing institutions, Dr. Sung Cheng Chih has quite a responsibility. Nonetheless, with rather unconvincing modesty he claims the Government of Singapore Investment Corporation (GIC) are “still novices ourselves” when asked what advice he would give to institutions who are just beginning to look more closely at their risk management.
Sung is Director of GIC’s Risk & Performance Measurement Department. In the years since GIC was first established in 1981, the organization has evolved a model of risk management that gives equal emphasis to control and efficiency. Sung explains: “The twin objectives give explicit recognition to the fact that our fund exists to take risk in order to earn good returns on a sustainable basis. Thus risk management cannot focus solely on control, for that would lead to risk minimisation and hence sub-par returns in the long run. Rather, we believe risk management should seek to ensure that investment risk is taken in a measured and responsible manner while at the same time promoting greater efficiency in how we take risk.”
In practice, GIC’s risk department is made up of two arms: the first focusing on risk control and mitigation, the other focusing on risk analysis and advisory.
Risk Control & Mitigation
“We view operational, counterparty, legal, regulatory and reputational risks as largely uncompensated risks,” says Sung. “The focus of risk management in these areas is on risk control and mitigation. Similarly, in the domain of market risk, the risk department is performing the investment compliance function, where key investment risks such as exposure to asset classes, countries, sectors, issuers, yield curves and spread curves are monitored and controlled via risk limits. Having said that, we do not seek to micro-manage the investment groups. Risk limits, where applicable, are generally set at the aggregate level, giving the business units discretion in how the limits are sub-allocated and utilised. This also helps to promote risk ownership and accountability at the line level.
“Just as important, we believe in a collaborative, problem-solving approach to dealing with complex operational risk issues where the risk department’s role is often one of facilitation and coordination, rather than command and control. For example, we have set up various working groups under our Operational Risk Committee to address the risks arising from the key cross-functional operations such as Portfolio Rebalancing, Liquidity Management, Pricing and Valuation, and New Product Approval. These working groups are chaired by the competent authorities in the various business functions and are structured in a way that gives them flexibility and the ability to make decisions quickly. The same goes for our Credit Risk Committee.
Sung admits the collaborative model for risk control has its limitations, as trust can sometimes be misplaced. “How we safeguard against potential abuses is best described by what my boss calls - after Ronald Reagan - the “trust but verify” approach. Take the example of investment limits. We have consciously kept the number of hard limits to be relatively small so as to keep the compliance cost within reason. However, we complement the formal compliance checks with regular surveillance actions to detect undesirable risk-taking behaviour by individuals.”
Risk Analysis & Advisory
Half of the staff in GIC’s risk department are deliberately not given control responsibilities. Instead, they have been tasked to help senior management and investment managers make better investment decisions, through what are known as the risk analysis and advisory functions. This is where most of their “quants” are deployed.
Sung explains how this works in practice: “In addition to providing regular risk reports and performance attribution analysis, the risk department acts as the de facto quant support team for the investment management groups. For example, in the public equities area, we have developed a full-blown portfolio management system that gives our equity managers the ability to screen stocks, construct portfolios, and manage the risk of their positions on an interactive basis.
“At a more strategic level, the risk department is engaged in advisory work aimed at raising the fund’s overall risk efficiency. For example, we have undertaken various research projects that have led to significant improvements in how we manage liquidity, hedge currency risk and run the completion management functions in equities and bonds. Our risk analysts also advise the chief investment officers on how active risk capital should be allocated in their respective asset classes. Yet another example of the strategic research work we do is the on-going project to devise and implement a risk-triggered rebalancing system for the total fund that reduces transaction costs while keeping the risk of deviating from the policy benchmark within tight bounds.”
GIC uses traditional risk metrics and, says Sung: “We don’t believe we have any special edge when it comes to the technical aspects of risk measurement,” says Sung. We have refrained from developing proprietary market or credit risk methodologies. Instead, we aim to leverage off what the traditional risk measures have to offer by tailoring them to the various needs we have. In our approach, product knowledge, understanding of investment strategies and institutional knowledge of our own firm are valued over technical prowess in risk modelling or derivatives pricing.”
As a broadly diversified institution with divisions dedicated to public and private markets, special investments and real estate, GIC embraces alternative strategies such as 130/30. “We employ a full spectrum of investment strategies in different parts of our fund, ranging from passive index-replicating strategies to pure long/short “alpha” strategies and everything in-between,” says Sung.
However, GIC hasn’t so far utilized structured products. Sung explains, “We don’t believe we are able to price and risk-manage such instruments better than the major investment banks or the leading hedge funds. We prefer to construct portfolios and investment strategies using simpler instruments that best reflect our investment ideas. We are, for example, regular users of plain-vanilla interest rate swaps, primarily for relative value trades and occasionally for hedging purposes.”
As part of its on-going project work, GIC has a major long-term project looking at the aggregation of market and credit risk embedded in the alternative “asset classes”, (hedge funds, private equity, real estate and infrastructure) with those found in the liquid publicly-traded asset classes such as bonds, equities, currencies and commodities.
Having refined sound risk management processes over a numbers of years, IPA asked Dr Sung what were some of the key things GIC has learned? These rules work for GIC:
1. Keep things simple.
2. Promote common sense.
3. Know what we know and what we don’t know.
4. Work with the investment managers, not against them.
5. Persist and persevere when swimming against the tide.
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