Managing Risk in Volatile Markets

Amid the resurgence of significant market volatility, many investors wonder whether risk management techniques have evolved since September, 2008. The events which brought giants such as Lehman Brothers and AIG to their knees raised questions of whether a misunderstanding of risk and risk management practices was at least partially to blame. Some even pointed the finger at risk models which they believe failed to properly account for “black swan” events – rare, unexpected events which in hindsight would have been predictable, such as the mortgage meltdown. Wylie Tollette, Franklin Templeton’s SVP and Director of Performance Analysis and Investment Risk, says avoiding over-reliance on models is important to mitigating risk:

“Models are just another tool in an investor’s arsenal. I think any management approach that’s solely dependent on one particular model or tool is always going to be vulnerable to the flaws and inconsistencies that exist in all models…Having a great risk model does not mean that you’ve really incorporated and integrated risk management into your practices. It needs to be supported at each step and really built up both from the top down, with support from the top of the organization, as well as from the bottom-up. For each of the investment decisions that are made, you’ve got to have risk management at every step.”