Added Value in Financial Institutions - Hardcover

Acar, Emmanual; Acar, E.; Acar, Emmanuel

Hardcover

ISBN 10: 0273650343 ISBN 13: 9780273650348

Publisher: Financial Times Management, 2002

Synopsis

Performance benchmarking has become common among fund managers; the 14 chapters here show how the same kinds of tools can be used to assess the contribution of senior managers and executives in financial institutions. The chapters cover four main themes: performance measurement, money management under constraints, leveraged investment, and executive compensation. The contributors are traders, investment professionals, bankers, economists, and actuaries; the guide is intended for executives, consultants, risk managers, portfolio managers, and derivatives traders. Annotation c. Book News, Inc., Portland, OR (booknews.com)

About this title

About the Author

Emmanuel Acar serves as Vice President for Citibank's FX Engineering Group. Formerly a trader at Dresdner Kleinwort Benson, BZW, and Banque Nationale de Paris' London branch, he has extensive experience in developing and managing quantitative strategies.

From the Back Cover

Emmanual Acar works at Citibank as a Vice-President within the FX Engineering Group. He was previously a proprietary trader at Dresdner Kleinwort Benson, BZW and Banque Nationale de Paris' London Branch since 1990. He has experience in quantitative strategies, as an actuary and having done his PhD on the stochastic properties of trading rules.

Excerpt. © Reprinted by permission. All rights reserved.

Preface

A century ago our world of finance theory was deterministic, based upon actuaries' calculations of the internal rate of return. Performance was solely measured as the return of an investment over a certain period of time. No reference was made to the fluctuations of this rate of return over the measured period. In 19S7 Harry Markowitz applied the theory of utility under uncertainty, developed in classical microeconomics, to the portfolio problem. This work led to the measurement of 'risk', the variance of the distribution of returns, which progressively became more meaningful than the average return. The whole distribution of return, summarized by the two first moments, became the cornerstone of the modern theory of finance. Stochastic calculus replaced classical financial mathematics and the behavior of assets became stochastic processes.

At the same time, investors started to enquire about the ability of their portfolio managers to deliver steady and continuous returns. Performance measurement first appeared as the publication of fund rankings. Nevertheless, the notion of risk behind fund rankings was not broadly recognized and remained largely unresearched. Indeed, it is only recently that rankings have started to being published by some firms on a risk-adjusted basis.

Today performance measurement is developing very rapidly in financial institutions. Increased competition among portfolio management companies, the so-called alternative investment strategies and globalization of the profession have been, for the first time, the driving forces behind this development as well as the growth in proprietary trading activities.

Together with these developments the necessity of standardizing the methods and processes became more and more urgent. Thanks to the work of actuaries and financial engineers a unique methodology for computing the performance of a portfolio of assets and the performance of a set of portfolios has been accepted worldwide. It remains today to integrate into these measures the risk parameter and to define a standardized risk adjusted measure.

Similarly, the notion of excess return and tracking error has spread among portfolio managers. Under the influence of the market efficient paradigm, according to which you cannot beat the market, benchmarking has become the ultimate in portfolio management and in financial consulting.

Now one has to have a careful look at these postulates and methods and ask I questions like the following: Do we want to have performance measures linked to an asset pricing model with all the simplifications this implies? Or do we prefer performance measures independent of any explanatory model? Are we looking for an explanation through a normative model or for a good description of the reality?

Can a managed portfolio of assets be considered itself as a traded asset, namely as a stochastic variable whose distribution can be summarized by the first two moments? Is the variance the best approach to define risk? Certainly not, because the function of stochastic variables giving the return of a portfolio is dependent on stochastic parameters which describe the behavior of the portfolio manager. Even then, if the assets have simple normal distributions there is no reason why the portfolio return should also be normally distributed. And if you introduce assets with truncated distributions, like options, things can only get worse.

What does this mean for benchmarking for alternative investing or hedge funds? To do as well or as poorly as the market, or as a mix of assets, is not the objective of these type of funds. What the investor is looking for is a steady and continuous performance whatever the market conditions and a quasi-insurance not to lose money.

This is not far from the requirements of a banking institution or any proprietary operation. Taking into account the leverage of these operations, it is of the utmost importance to manage the risk through means other than the traditional ones. What really counts is the probability of loss or the average loss under a certain confidence interval as it is proposed in the value at risk approach. This measure of the maximum loss that can occur over a certain period of time is increasingly widespread in banking I and portfolio management and it will certainly be a basis of the prudent approach to pension fund regulation.

Finally what is performance and for what purpose do we want to measure it? I Is it to predict the future? If so, is the past performance of an active manager a good proxy of the future performance? Or are we trying to measure the ability to deliver a given return, absolute or relative? Are we interested in the adequacy of the processes in place relative to the objectives assigned to the portfolio managers?

This book provides a diverse insight into many of these issues by compiling a varied collection of papers from traders, investment professionals, bankers, economists and actuaries.Jean Berthon
Chairman of AFIR (Actuarial Approach for Financial Risks)

Edition details

• Publisher: Financial Times Management
• Publication date: 2002
• Language: English
• ISBN 10: 0273650343
• ISBN 13: 9780273650348
• Binding: Hardcover
• Edition number: 1
• Number of pages: 256