Book Reviews 2016 Volume 11 Issue 1
Investment Risk Management (a review)
Investment Risk Management Oxford University Press
Written by experts in a nontechnical style, the chapters in this book cover a breadth of risk-related topics—from the foundations of risk management, to the quantitative assessment of risk to the future of risk management. Although certain emerging areas of risk are not discussed and the survey approach precludes more in-depth study, this book provides for those practicing, studying, or simply interested in risk management a first-rate reference.
When I was a child my family and I played the board game Risk, in which outcomes were based on a combination of strategy and rolls of the dice. The game taught me the statistical basis of particular outcomes—the distinct possibility that I might not achieve the result I wanted on a particular turn or in the overall game. As an adult, business school and the CFA Program taught me that there are many forms of business and financial risk, many of the risks are interlinked, and solutions are available to mitigate or counteract some of these risks. Financial historian Peter Bernstein even wove together a compelling narrative about risk and its evolution in his wonderful bookAgainst the Gods: The Remarkable Story of Risk(John Wiley & Sons, 1996).
Bernstein’s book was released, however, before the complexities of risk vaulted from board games to headline news. Among its other effects, the 2008 financial crisis brought home to us the systemic intricacies of our interconnected financial system. With the timely publication ofInvestment Management Risk, editors H. Kent Baker at American University and Greg Filbeck at the Pennsylvania State University at Erie provide an updated, definitive, and comprehensive overview of risk, with 30 authoritative chapters contributed by 47 experts.
The fourth in theFinancial Markets and Investments Series, the book is divided into six sections:
Foundations of Risk Management
Types of Risk
Quantitative Assessment of Risk
Risk Management and Asset Classes
According to the editors, the “book presents the crux of various research studies in a straightforward manner focusing on the comprehension of study findings, rather than on the details of mathematical frameworks” and, therefore, “helps to bridge the gap between research findings and general risk management knowledge and practice.” (Casual readers should note that the focus away from mathematical findings does not mean there are no equations, but there are fewer than one might find otherwise.) The nontechnical approach means the book can be enjoyed by a broad range of readers. The editors may be a bit optimistic, however, in their assessment that it will be of interest to “sophisticated practitioners, investors, academics, and graduate-level finance students” alike. The last mentioned are a far more likely audience.
The clarity of scope and purpose shown in the book’s first section on the foundations of risk management is found throughout the book. For example, the first section begins with a chapter by the editors in which they introduce the subject—outlining the scope of measuring and managing risk, highlighting the field’s three main components, and then telling readers which of these components will be the focus for subsequent chapters in the section. This well-organized approach helps readers decide whether a topic has been adequately addressed for their purposes or whether they should look for supplemental material. For readers who want to learn more, the authors offer helpful and specific references in the text, including a quick note about each reference’s focus. Summary references follow each chapter. Academics will find the chapter-end questions especially helpful.
Despite its breadth, the book still misses several key emerging areas in the financial risk arena. A full third of the chapters are devoted to types of risk, including one on governance risk, but conspicuous by its absence is any discussion of (let alone separate chapters on) environmental or social risks. Environmental, social, and governance (ESG) risks and measures to combat them are already mainstream for many investors, especially institutional investors. These concerns have become basic in the same way that country risk became a staple for investors in the 1980s.
The book does include a chapter on operational risk, but it focuses squarely on financial institutions. Only two paragraphs address operational risk for nonfinancial institutions. Cybersecurity and disaster risks may once have been viewed as simply subsets of operational risk, but today they are often considered separately in financial analysis. Cybersecurity breaches are increasing in frequency and severity, with a concomitant potential impact on a company’s brand and value. Corporate disasters—such as we saw with Union Carbide in Bhopal, Exxon in Alaska, and BP with Deepwater Horizon—are perhaps rarer than cybersecurity breaches, but they have even higher financial stakes.
Another emerging area not covered in the book relates to the risks posed by deflation and central banks’ lingering low interest rates since the 2008 financial crisis. What had seemed a temporary response to the financial crisis appears to have ceased being transient and thus constitutes a risk to policymakers’ future responses to economic slowdowns or crises and to retirees’ wealth.
To be fair, readers should keep in mind that the editors must have outlined their book and called for chapter submissions a few years before publication, when the likelihood of some of these underdiscussed risks seemed remote.
Finally, a similarly understandable oversight relates to the book’s empirical roots, organization, and academic focus. The book is exceptionally well edited, but its subject-by-subject organization means that retail investors are likely to have difficulty integrating certain essential points. For example, the chapters on behavioral risk, inflation risk, country risk, and market risk all focus on highly pertinent risks central to these investors, but without a synthesis of the key points, readers may find it difficult to draw practical lessons from the discussions. A comparison ofInvestment Risk ManagementwithDeep Risk: How History Informs Portfolio Design (Investing for Adults)by William Bernstein (vol. 3, 2013), in which the author draws on history to reframe the risks investors face and to offer practical guidance, elucidates the trade-off between a focused narrative and the broad, survey approach taken by Baker and Filbeck.
Despite these omissions,Investment Management Riskis an excellent survey. Those practicing, studying, or simply interested in risk management will find it a first-rate reference and perhaps a reminder of how much the field has evolved since the board games of their youth.
Ian Robertson, CFA, is a portfolio manager, director, and vice president at Odlum Brown Limited, Vancouver, British Columbia.