Perspective on Risk ManagementMay 2012
The Art and Science of Managing Risk
With economic turmoil and the resulting market volatility over the past several years, managing risk in portfolios has received greater attention. Active risk management has always been core to Fiduciary Trust’s investment management approach, and our processes have been designed to help maintain appropriate risk/reward balances relative to client objectives through variable market environments.
Investing across market highs and lows for 80 years has taught us to expect the unexpected and to have the people and processes in place to navigate both the risks and opportunities of the global marketplace.
FIDUCIARY TRUST EMPLOYS A MULTI-DISCIPLINED RISK MANAGEMENT PHILOSOPHY
We believe the basic goal is not to eliminate all risk; rather it is to seek to maintain risk levels that we believe are appropriate for each client’s circumstances. We apply a three-pronged philosophy to managing risk that seeks to ensure that it is recognized, rational and rewarded.
How Do We View Risk?
Risk is inherent to market participation. That is why we take a comprehensive, disciplined approach to risk management, looking at both risk and return from multiple perspectives. The key to our approach lies in understanding our clients’ risk tolerances, and assessing both quantifiable risks as well as risks that are qualitative in nature.
While risk is a common term, few people tend to share a common definition of it. Many investors view risk as the possibility they will lose money, or that their investments will fail to meet their objectives. Others view it as the chance an investment will perform poorly compared to a similar security or benchmark. In either case, risk becomes a difficulty when it is unintended, misunderstood or uncompensated—all of which come to light when there are gaps between investor expectations and actual experience. And, for assets held in trust, investment fiduciaries must manage risk to meet the directives of the trust, while considering the needs and expectations of beneficiaries for multiple generations.
While no methods are capable of fully mitigating risks related to investing, our formalized controls seek a reasonable level of protection by identifying and actively addressing situations that may negatively affect portfolios. The importance of these controls is shown not only through policies and procedures, but also through the alignment of our portfolio managers with our core values and philosophy as a firm.
A Three-Pronged Risk Management Approach
Through our formalized and closely-controlled processes we seek to identify and recognize potential risks at the overall portfolio level and at the individual security level.
RECOGNIZING PORTFOLIO RISK
At the onset of portfolio construction, we consider each client’s risk and return objectives when we develop their long-term strategic allocation target, one that we believe will provide a high probability of meeting their long-term objectives. We apply both historical and forward-looking analyses to establish risk parameters and to determine the asset class weightings that we believe will collectively match each client’s desired risk/reward expectation.
Allocation recommendations are made by our Asset Allocation Committee, led by our Chief Investment Officer and our Director of Fixed Income Strategies. Decisions are informed by research and analysis provided by senior analysts in our Strategic Advisory Group, as well as by senior investment professionals across the firm. Our teams continually analyze the market environment to recognize areas of heightened risk, and actively adjust asset class exposure recommendations tactically as market conditions change.
As an example, our tactical shifts in emerging market weightings demonstrate how our process works in practice. In early 2010 our tactical position was overweight compared to our long-term strategic target because we viewed greater risk-adjusted return opportunity. As we approached 2011, we retreated to a below-target weighting. Our long-term strategic view remained the same--we believe emerging markets will bring opportunities to our clients. However, tactically we became more cautious due to circumstances that we believed would pose higher risks in these markets in the near term, such as the European debt crisis, China’s ability to engineer a soft economic landing and slower worldwide growth overall. In 2012, we returned to our long-term strategic recommendation of 10% of a balanced growth portfolio because we believe some of this risk will diminish.1
MANAGING SECTOR AND SECURITY RISK
Each of our portfolio managers is a member of our Equity Strategy Group and participates on one of ten sector research teams. Their research and views on risks and opportunities are shared regularly via:
- Daily research meetings
- Weekly industry roundtables
- Monthly sector reviews
- Monthly portfolio management meetings to discuss themes and trends
As part of Franklin Templeton Investments, we also have direct access to over 35 global research analysts and 46 investment professionals who provide extensive analysis and intelligence on over 2,300 securities.
The benefits of the firm’s proprietary research and risk analysis can be illuminated during crisis events, such as the 2011 tsunami disaster in Japan. Our research teams, including on-the-ground investment professionals in Tokyo, quickly identified several high risk sectors, including insurance providers and several consumer goods areas. During the daily research meetings, our portfolio managers evaluated the events as they unfolded and developed strategies for adjusting portfolio allocations to highly impacted sectors as deemed appropriate.
The second prong of our risk management philosophy is to ensure that identified risks are an intended and rational part of each client’s portfolio strategy.
Fiduciary Trust employs several controls with the goal of ensuring that portfolio risks are reasonable, calculated and in line with client risk tolerance levels.
- Regular peer evaluations. Portfolios are regularly reviewed through our portfolio manager peer review process. Portfolio details--including factors such as asset class weightings, sector allocations and securities holdings—are reviewed in context of each client’s objectives. Diversions--such as concentrated positions, allocations that veer from the firm’s views or other flags that may indicate elevated risk--are identified. The portfolio manager provides rationale for identified diversions, and addresses any areas perceived as having elevated risk potential. The input from the collective team is communicated across the firm to bring the best thinking to every portfolio manager.
- Quarterly portfolio risk reviews. We utilize a data-driven portfolio review system that reports statistics on each client’s portfolio. Statistics are evaluated individually as well as across all portfolio managers. Any outlying results are highlighted and reviewed by our Chief Investment Officer and the head of our Investment Management group.
- Ongoing investment reviews. Each portfolio is evaluated on an annual basis by our Trust and Investment Review Committee. Having a critical view, the committee seeks to ensure that the portfolios are invested prudently. The committee focuses on how each asset contributes to a portfolio's overall investment objective, and confirms that portfolios are being managed in accordance with client-specific investment guidelines and restrictions. For trust assets, the committee views investment management decisions in context of provisions within the trust document to ensure that the portfolio is being managed to best meet the interests set forth by the trust document. The committee is appointed by the Board of Directors and is led by our Chairman of the Board and the head of our Investment Management group.
SENIOR LEVEL OVERSIGHT
Fiduciary Trust utilizes a number of senior level committees that are responsible for overseeing portfolio and operational activities.
- Counterparty Credit Committee. Any banks, brokerages and investment banks that act as trading partners are reviewed to identify potential stability risks. While failures are very rare, analyzing the stability of these entities and diversifying across counterparties is critical to avoiding such risks. Fiduciary Trust did not experience any losses due to the 2008 collapses.
- Complex Security Review Committee. Complex securities are reviewed from an operational, legal and risk perspective and must be approved by the committee prior to their implementation in a portfolio.
- Valuation and Liquidity Oversight Committee. Securities are reviewed from a liquidity perspective to inform portfolio managers of their ability to trade the security in the marketplace. Independent pricing is implemented for all securities that cannot be priced by a third party, ensuring that the values of these securities are accurately reflected.
Portfolios are measured on relative and absolute performance to evaluate whether risks have been appropriately rewarded. Each portfolio’s asset allocation, sector weightings and holdings are reviewed to identify gaps in performance expectations.
Investment results of every portfolio are reviewed annually by the head of our Investment Management group. Performance is evaluated relative to benchmarks and peers, and more importantly, on a risk-adjusted basis to seek to ensure that risks being taken in portfolios are being appropriately compensated.
DATA ANALYTICS AND MODELING
Our Asset Allocation Committee reviews and retests our long-term asset allocation strategies on an annual basis. The committee uses a blend of quantitative and qualitative inputs to determine a series of recommended strategies that deliver a range of risk/reward profiles. The team also analyzes market trends and extrapolates them on a forward-looking basis so that our views regarding risk evolve with long-term market trends.
As an example, our long-term strategic asset allocation recommendation to emerging markets has gradually increased over time, from 3% of a balanced growth portfolio in 2007 to 10% today.1 This evolution is based on statistical measures as well as by evaluating global trends, such as increased information availability and better transparency of the management and balance sheets of the companies in these regions. While 2011 was exceptionally volatile due to many factors converging worldwide, our analysis identified decreased relative risk in this area versus potential returns over the long term.
TRADE MONITORING AND EXECUTION
Our seasoned equity and bond traders actively seek the best execution for orders placed by our portfolio managers. They monitor all trades for potential errors and ensure transactions are successfully executed.
LEARN MORE ABOUT HOW WE MANAGE RISK IN CLIENT PORTFOLIOS
We encourage you to speak with your Fiduciary Trust contact to learn more about our risk management approach or to discuss risk management in context of your own portfolio.
1. Our clients’ portfolios may not reflect these asset allocation recommendations as each client’s portfolio is individually tailored, and allocations are customized based on each individual client’s situation. Portfolio holdings and investment strategies may vary depending on factors such as market and economic conditions.
This communication is intended solely to provide general information. The information and opinions do not represent a complete analysis of every material fact. Statements of fact have been obtained from sources deemed reliable, but no representation is made as to their completeness or accuracy. The opinions expressed are not intended as individual investment, tax or estate planning advice or as a recommendation of any particular security, strategy or investment product. Please consult your personal advisor to determine whether this information may be appropriate for you. This information is provided solely for insight into our general management philosophy and process. Historical performance does not guarantee future results and results may differ over future time periods.
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