Tuesday, November 03, 2009

RiskMetrics Goes Corporate

I always have admired RiskMetrics, because they offer straightforward advice about how to measure risk. My career as a risk manager started as an attempt to implement the then-new (1994) RiskMetrics Value-at-Risk methodology to the KeyCorp trading operations. Sure, for any nuanced strategy, they are 'academic', in that they do not understand a lot of parochial issues related to, say, risk arb, but for setting a benchmark, understanding certain tools are useful, and being clear, I give them an A+.

Thus, I was saddened to see their acquisition of the KLD Research & Analytics, "a leader in environmental, social and governance (ESG) research and indexes for institutional investors", because it highlights the essence of Risk Management as a corporate enterprise. KLD's politically correct indices are lame, allowing companies to justify holdings to investors via moral preening. Having the imprimatur of some socially conscious busybody just says you are trying to get by on good intentions as defined by conventional wisdom.

Who's to say if investing in, say, Al Gore's latest initiative is morally superior, better for the world's people, than giving more money to Exxon? After all, Gore's senate tie breaking vote back in 1994 started this corn-based ethanol boondoggle, which is now an entitlement that will take decades to undo. Meanwhile, farming for ethanol takes more energy than it produces when you add up all the indirect cost (as any good economist should). Further, it raises the price of corn, and hurts natural aquifers. In contrast, Exxon produces oil that can then be used by centralized power plants or machines, instead of burning biomass, which is much less efficient.

That RiskMetrics thinks moral posturing complements their activities highlights how senior risk management as a profession is mainly about appearances and going through the motions. To be specific, official risk management, which is what RiskMetrics now advises upon, is mainly staffed by prigs and props. A prig is someone wedded to a theory that explains everything, and can be highly mathematical and conventional, like Phillipe Jorion, or highly obtuse, like Nassim Taleb's insight that 'risk is what you don't expect' [which I find not profound, but irrelevant]. The key is they are true believers, have credibility as experts, and are true idiot-savants: they have a lot of knowledge, and a lot of ignorance.

Then there are the props, the suits who actually run senior risk management posts, and they basically have a full time PR job, catching flak from outsiders about decisions not made in their presence. Official Risk Management futility comes from the fact they are graded on their ability to generate reports read by people three levels removed from a business, so that why the props need the prigs, for references. The prigs need the props to add credibility to what they do, though I think it would be most accurate to say there's some truth in what prigs do, but only if you know where to find it. Nuance, the things that really matter for a businesses survival, don't travel up the chain well, so everything is fit into cookie cutters based on the most recent conspicuous financial failures.

I wonder if the RiskMetrics management has convinced themselves this really addresses risk, or they realize it's simply the way the game is played, and they have to make a living. I'm too cynical to pull it off convincingly. I'm saddened by the whole thing because I understand a lot about actual risk management, but realize how irrelevant that knowledge is to risk management as practiced by large, regulated firms.

Macro, Risk Management. These are two fields I know enough about to avoid.

No comments: