Portfolio Risk Management

A classic tenet of modern portfolio theory is the direct, positive relationship between risk and return: the more risk taken, the greater the investment reward over long periods of time. At eBIS, we subscribe to this theoretical relationship, but with some caveats. We believe that, if actively monitored, some risks can be mitigated and/or managed to limit downside exposure, while preserving much of the portfolio’s upside return potential. Through a comprehensive approach to risk assessment, we first categorize and quanitfy the various flavors of risk, then implement measures to manage them through time, keeping a keen eye on the changing landscape of investment products, market behavior, and regulatory policy.

Moreover, regulatory policy can force asset managers to adjust their risk-taking behavior. With a long track record of regulatory policy and adherence consulting, eBIS can guide your institution through regulatory change, ensuring structural changes are enacted to facilitate compliance.

Combining advanced risk measurement techniques with a sharp focus on regulatory policy, eBIS offers your institution a comprehensive solution for compliant downside risk management. Please read below for each offering in our Portfolio Risk Management solution suite:


Perhaps the most important risk mitigation technique in modern portfolio theory is the application of correlation analysis.  Each asset class has a tendency to rise and fall based on its own performance drivers, which usually to relate to economic cycles.  Correlation analysis is the study of each asset class’s performance variance, and relating it to the performance variance of every other asset class.  With this information, portfolios can be constructed that minimize, on a historical basis, the volatility of the aggregate portfolio.  Low portfolio volatility is a key psychological driver for investor confidence and strategic discipline, which can help investors reach their financial goals.

Further, correlation analysis takes on increased significance in investment environments that force increased risk taking, such as low interest rate environments. Low interest rates can be thought of as a form of financial repression, a “tax” on savers and capital owners if the after-tax interest received does not eclipse the rate of inflation.  To keep up with inflation in a low interest rate environment, investors must move further out on the risk curve to seek higher returns.  In this scenario, correlation analysis becomes a critical form of risk management, as the co-movements in asset prices across risky asset classes contributes significantly to the volatility of the overall portfolio.  For instance, in order to reach a retirement income goal, an investor might need to invest a large percentage of assets in riskier classes, like equities, junk bonds, and alternatives.  In this scenario, we believe the best way to limit financial anxiety is to study the historical performance relationships across these risky assets and assemble portfolios that both zig and zag, containing investments that have shown to perform well, in absolute or relative terms, in each market cycle environment.

At eBIS, we take correlation analysis very seriously.  We compile and maintain a correlation matrix across asset classes that informs our portfolio management and asset allocation recommendations.  We pay particular attention to historical periods when traditional risk assets, such as equities, have performed poorly, and seek to identify complimentary asset classes that performed relatively well during these periods.  Further, we tie this correlation analysis to a four-quadrant market cycle category, such as high-growth inflation, to build a relationship between economic drivers and specific asset class performance.  With this information, we can further refine asset allocation strategies that can buffer downside risk in every economic cycle.

We strongly believe that investors can improve their financial success by employing correlation analysis in the asset allocation process.  Limiting volatility and smoothing returns through time is one of the best methods to increase investor confidence, increase retirement/savings contributions, and limit emotional trading decisions.


Credit risk is one of the most important and pervasive risks to manage in an investment portfolio.   It can rear its head in many forms, in over-the-counter derivatives, bonds, loan portfolios, and even indirectly through equity investments if a high debt burden increases the firm’s cost of capital.

In fact, some credit risk may not even be readily apparent, as the Global Credit Crisis revealed, when AAA rated securitizations defaulted literally overnight.  That’s why we recommend a multi-tiered approach, using a number of empirical inputs, whenever possible.  For instance, an extensive portfolio of credit risk might necessitate internal fundamental analysis through scorecards, supplemented by NRSRO ratings.  Other credit risks, such as securities and margin lending, might be influenced by market variables, where the credit risk increases or decreases as markets fluctuate.  In these cases, a value-at-risk (VaR) calculation can reveal potential downside risk at a given confidence interval.  Clearly, credit risk must be identified, quantified, and analyzed in its many forms.

Further, we believe that credit markets are not as efficient as equity markets, necessitating diligent management of credit risk.  Credit information is not disseminated uniformly in all markets, and not all market participants interpret available credit data rationally and accurately (reference Credit Crisis NRSRO ratings and the civil litigation brought by the U.S. Government  against Standard & Poor’s, the decrease in yield following AAA credit downgrades for both the U.S. and the U.K., and the post-Crisis precipitous decline in European sovereign debt ratings & the OECD questioning their usefulness).  We contend that “the market is the market”, reflecting all available information and the expectations of prudent investors, is a flawed assumption in credit markets.

Credit risk can be effectively managed if actively monitored and analyzed.   The best way to manage credit risk can depend on a number of factors:  the regulatory environment, macroeconomic trends, available credit in the marketplace, and competing risks, such as duration, to name a few.  We help you navigate these factors to choose a level of credit risk that suits to your risk tolerance and/or regulatory limit, while keeping a diligent eye on the costs involved.  We offer a long history of success in capturing, analyzing, quantifying, and reporting credit risk, as outlined in our Success Stories.


Market risks are numerous and varied and can derail an investment portfolio if not managed properly. Interest rate, reinvestment, political/regional, currency, notional value of derivatives, inflation, and global supply/demand dynamics are all examples of market risks that influence investment returns.  When constructing a portfolio of assets, or quantifying the downside risk of an existing portfolio, it’s important to understand the market risks that influence returns.

At eBIS, we feel two tools are necessary to assess, and manage against, potential downside risk in investment portfolios: historical correlation analysis and simulations.  In this vein, we think it important to understand past market risks and take a reasonable attempt at predicting these risks in the future.  For historical analysis, please reference our Portfolio Risk Management solution for Correlation Analysis.  Regarding future probabilities, simulation software offers a useful tool to gauge potential future risk.  These simulators use actual portfolios of assets as inputs.  The simulations can run stochastically (randomly) or use empirical historical volatility data of the asset classes involved to model price movements through time.  Either way, the simulations provide a range of potential outcomes, allowing for quantification of downside price risk.  For instance, a simulation can provide the probability of outliving your assets at a given confidence level, e.g., 95%.  Given the power of negative compounding, downside price movements early in a portfolio growth or distribution cycle, such as at retirement, can have significant effects on wealth sustainability.  These market risk simulators show the effects of some of the worst market outcomes, and provide the ability to adjust input parameters, such as volatility assumptions, drawdown rate, and term of withdrawals.  With this information, both client and portfolio manager can make informed decisions about the appropriate asset size and risk level to achieve peace of mind and income security.

For institutional portfolios of assets, market risks must be quantified, with econcomic and/or regulatory captial allocated to cover downside events.  To quantify this risk, systems must be put in place to understand historical risks and estimate potential future risk.  Through our professional consulting services and solution toolkit, we offer institutional risk managers the tools to implement sound market risk monitoring and reporting solutions, using our innovative ideas and industry best practices as catalysts.

We have a long history of modeling and analyzing the effects of market factors on portfolios of assets.  Please reference our Success Stories in quantifying institutional interest rate and notional derivates risk.  We can bring the same innovative thinking and diligence to your efforts to manage the downside market risks embedded in your portfolio of assets, both for institutional  and individual portfolio risk management.


Liquidity risk can be defined in one of two categories: market and funding liquidity. Market liquidity risk is an investment portfolio risk that affects bid/ask spreads on securities, potential downside price movements when liquidity providers diminish or supply overwhelms demand, and the holding period necessary (known as immediacy risk) to sufficiently liquidate a position (depending on size). Funding liquidity risk is an institutional balance sheet risk that quantifies the probability that liabilities cannot be serviced when they fall due or only done so at an uneconomic price.

Market liquidity risk affects every investment in a portfolio. Even the most highly rated, actively traded securities, such as those issued by the U.S. Government, are under medium to long-term liquidity pressure from mounting public debt and competitive pressures from emerging bond markets in China and other emerging economies. Perhaps most importantly, liquidity is often a function of market environment. As the Global Credit Crisis (GCC) showed, what were once considered very liquid securities can become virtually illiquid overnight, requiring significant price haircuts, large bid/ask spreads, and even government-sponsored purchase programs to provide buyers in the marketplace. This risk must be defined explicitly in any portfolio construction scenario, with appropriate buffer capital in reserve and/or allocation strategies adjusted to account for downside price potential.

Market liquidity risk can increase with position size relative to capitalization, or market depth. For instance, a large position in a small capitalization stock may need to be liquidated at a price well below current market bid, as the supply of buyers might not be adequate to absorb the order. Investors need to be cognizant of this type of liquidity risk when investing in low capitalization issues.

Holding period market liquidity risk is another very important risk to consider in an investment portfolio. Some investments, such as private equity, limited partnerships and accredited investor hedge funds, limit the liquidity of the investment to pre-defined redemption windows. For instance, a hedge fund might have a semi-annual redemption window, meaning an investor might be forced to wait as long as six months to get his/her money back, and only through the valuation method defined in the fund’s prospectus, which might not be based on current market valuation. To point, during the SEC-ordered liquidation at SAC Capital Advisors, some investor funds were tied to investments, known as side pockets, that had no active market, requiring years to identifiy a buyer. Return of investor capital was delayed until a buyer was found, likely at a substantial discount to intrinsic value, a capital loss attributable to low liquidity. At eBIS, we avoid prescribed holding period liquidity restrictions, requiring the ability to liquidate a holding at least on a daily basis, with a preference for intra-day liquidity. This approach provides the flexibility to deliver redemption cash to investors on their timelines, not those of a third party.

Further, regulatory dynamics can influence liquidity in some asset classes and should be monitored closely. For instance, the Volker Rule, as passed under the Dodd-Frank legislation, restricts the ability of deposit-taking institutions from investing the bank’s own money using proprietary trading techniques. Some argue that a broad interpretation of this legislation could limit a bank’s market making business through its broker/dealer affiliate, and thus reduce overall market liquidity for some securities. Similarly, the ban on over the counter (OTC) derivatives, may, in the short term, limit liquidity for certain types of derivatives where exchange mechanisms, such as swap execution facilities, are inadequate or not sufficiently diversified to meet market demand. With bank capital rules for funding liquidity risk under the Basel accords, financial institutions are now penalized to a greater degree for owning anything other than the highest rated sovereign debt and cash equivalents, which could further decrease market liquidity for credit risk instruments. In summary, we know it’s important to stay focused on all such regulatory developments and have a plan to assess and mitigate any negative consequences for portfolio positions. At eBIS, we provide this ongoing service to our clients, keeping them aware of changing regulatory dynamics, and using this information to stay ahead of the curve in our risk analysis and portfolio modeling services.


The financial services industry is one of increased, and rapidly changing, regulation.  Influencing regulatory policy can mean lower operational costs for market players, while formulating the right industry rules can provide order and stability to financial markets and lower overall market risk.  Both are important considerations for the health of our economy.  What is the right balance between the two?  When new rules are enacted, what is the right balance between ease of implementation and business benefit?  eBIS stands to help address these questions, providing services on both sides of regulation: the formulation of policy and the adherence to documented rulemaking.

For those looking to influence policy or formulate rules, one variable is constant: the need for timely, relevant data.  Think tanks use statistics to frame policy arguments.  Regulatory agencies and legislative bodies need information on their constituents to inform their agendas.  In either case, intelligently crafted technology is the vehicle upon which they rely to persuade or govern.  eBIS serves as this data steward, understanding the points of analysis and then delivering a solution to present the right information for informed decisions.  Are you a lobbyist trying to understand the costs of regulatory disclosure in the pension plan or hedge fund industry?  Is your regulatory agency trying to decipher what swap contracts are most appropriate for guaranteed exchanges?  Is your agency struggling to implement credit and liquidity risk rules for securitizations without the ratings of NRSROs?  The right approach lies in analyzing the right data.  eBIS can deliver it with our comprehensive professional consulting services and solution toolkit.

Similarly, for compliance, eBIS offers its Solution Delivery Lifecycle toolkit to help clients meet financial regulatory requirements and monitor market activity.  From government mandated stress tests to Basel II & III compliance to new disclosure requirements for retirement plan sponsors and hedge funds, institutions need a consolidated data store from which to calculate and report, and a process to construct, administer, and enhance it.  Similarly, government agencies are burdened with monitoring activity within and across financial markets, sometimes requiring near real-time insight to events that can disrupt or endanger them.  The “flash crash” on May 6, 2010, and speculative derivatives trading in 2008 brought this need to light.  Our toolkit addresses these needs, providing a complete package for solutions in regulatory compliance management.  In addition, we can provide cost/benefit analysis on modeling and disclosure alternatives, providing insight to the time, resources, and technology costs in implementing each option.  Combined with capital savings projections or estimates for quicker data insight, we provide the complete picture and the ability to choose a model with the greatest value.

We’ve had a lot of experience in this endeavor, helping multiple top 10 internationally active banks meet their Basel requirements, and can translate that experience to help firms address the latest regulation.  See our Success Stories for examples of our clients’ success in regulatory compliance and visit our Knowledge Center for white papers and best practice documentation in these areas.  Our experience can help your firm or agency navigate the latest regulatory challenges.