Views from the Dark Side Bill Martin - Global Head of Investment Risk GARP/ISDA Risk Forum 19 December 2001

INVESCO Asset Management Limited - Regulated by IMRO 2 Views from the Dark Side The Dark Side refers to the “Buy” side – Investment Management – Asset Management – Fund Management Why “the Dark Side”? – ”Accept the power of the Dark Side” Darth Vader to Luke Skywalker – Star Wars IV

INVESCO Asset Management Limited - Regulated by IMRO 3 Views from the Dark Side Traditionally, the leaders of “risk management” have come from the “Sell” Side of investment banks – Mark-to-Market followed by commercial banks, – Traditional credit expertise followed by consultants, advisors, academics, rocket scientists, IT propeller heads, We created an Industry!

INVESCO Asset Management Limited - Regulated by IMRO 4 Views from the Dark Side What would one expect from a “Sell Side” risk manager: – Specialist expertise by risk discipline: Market Risk Credit Risk Operational Risk (maybe) Portfolio Management Regulatory Issues/Basle II

INVESCO Asset Management Limited - Regulated by IMRO 5 Views from the Dark Side What would one expect from a “Sell Side” risk manager: – Specialist expertise by asset class: Fixed Income Equities Credit Risk (structuring, pricing, documentation, recoveries) Credit Trading Derivatives/Exotic Derivatives Currencies/Commodities Emerging Markets

INVESCO Asset Management Limited - Regulated by IMRO 6 Views from the Dark Side In moving to the Sell Side: Is this appropriate? Is it sustainable? Are the skills transferable? Are they sufficient? Is the knowledge transferable? What’s the big deal?

INVESCO Asset Management Limited - Regulated by IMRO 7 Views from the Dark Side The big deal? O P M

INVESCO Asset Management Limited - Regulated by IMRO 8 Views from the Dark Side The big deal?: Other People’s Money

INVESCO Asset Management Limited - Regulated by IMRO 9 Views from the Dark Side What do they want?: – Performance Absolute Relative

INVESCO Asset Management Limited - Regulated by IMRO 10 Views from the Dark Side Investment Management - the challenge: – To deliver superior investment performance in a manner that is consistent with the mandate and/or expectations of our clients.

INVESCO Asset Management Limited - Regulated by IMRO 11 Views from the Dark Side Investment Risk - the challenge: – To design and implement an approach to investment risk management that adds value to the global investment management process

INVESCO Asset Management Limited - Regulated by IMRO 12 Views from the Dark Side Global Investment Management Process: Macro research & asset allocation Micro research & stock/se curity selection Portfolio Construc tion Risk Manage ment Perform ance Monitori ng

INVESCO Asset Management Limited - Regulated by IMRO 13 Views from the Dark Side Investment Risk – how would you define it: – As an investor: Investment Risk: the failure to deliver investment performance that is consistent with the mandate and/or expectations of our clients. Unpleasant surprises

INVESCO Asset Management Limited - Regulated by IMRO 14 Views from the Dark Side Investment Risk – how would you define it: – As a risk manager: Investment Risk: the measurement and assessment of exposure held by Invesco Global and its clients’ portfolios to expected and unexpected volatility in financial performance and the requirement to ensure that exposure to unexpected volatility is managed effectively and comprehensively at product level.

INVESCO Asset Management Limited - Regulated by IMRO 15 Views from the Dark Side Investment Risk – What are the Strategic Objectives?: – Play an active, integral role in the firm’s global investment management process.

INVESCO Asset Management Limited - Regulated by IMRO 16 Views from the Dark Side Global Investment Management Process: Macro research & asset allocation Micro research & stock/se curity selection Portfolio Construc tion Risk Manage ment Perform ance Monitori ng Buy List – Credit Risk Assessment Volatility Analysis “What if…”

INVESCO Asset Management Limited - Regulated by IMRO 17 Views from the Dark Side Investment Risk – What are the Strategic Objectives?: – Embed a strong, consistent risk culture within the firm’s global investment management process. Risk Culture relates to the behavior – the proactive management of risk vs. reward. As we work to deliver superior investment performance, actions must be consistent with any client’s mandate and/or their needs.

INVESCO Asset Management Limited - Regulated by IMRO 18 Views from the Dark Side Investment Risk – What are the Strategic Objectives?: – Define clearly and precisely the design and structure, roles and responsibilities, priorities and deliverables of Global Investment Risk.

INVESCO Asset Management Limited - Regulated by IMRO 19 Views from the Dark Side Investment Risk – What are the Strategic Objectives?: – Play an active role in the growth of the firm through participating in: investment performance communications, client presentations, new product development.

INVESCO Asset Management Limited - Regulated by IMRO 20 Views from the Dark Side Investment Risk – What is the end game? – To minimize the firm’s exposure to: – Unexpected volatility of investment performance relative to mandate – Persistence in investment underperformance – Loss of client assets/Loss of growth in client assets – Loss of revenue/Loss of growth in revenues – Loss of capital

INVESCO Asset Management Limited - Regulated by IMRO 21 Views from the Dark Side Do we design by risk type?: – Specialist expertise by risk discipline: Market Risk Credit Risk Operational Risk (maybe) Portfolio Management Regulatory Issues/Basle II

INVESCO Asset Management Limited - Regulated by IMRO 22 Views from the Dark Side Do we design by specialisation?: – Specialist expertise by asset class: Fixed Income Equities Credit Risk (structuring, pricing, documentation, recoveries) Credit Trading Derivatives/Exotic Derivatives Currencies/Commodities Emerging Markets

INVESCO Asset Management Limited - Regulated by IMRO 23 Portfolio Constructi on Views from the Dark Side The design: Investm ent Risk Policy (Minimu m Standard s) Contributio n Attribution and Performan ce Assessme nt Product & Style Integrity Assessm ent Risk-adjusted Portfolio Analysis (Volatility Analysis; “What if” analysis) Core Competencies Drive the Investment Risk Management process to the performance generating level of the organization across all products, including funds managed directly as well as those managed on an advisory basis. Exception Reporting Local RMC GRMC Global Risk- Adjusted Performance Analysis (GRaPA) Investment Risk Managers GMAC

INVESCO Asset Management Limited - Regulated by IMRO 24 Views from the Dark Side Contribution, Attribution and Performance Analysis – Contribution – What factors contributed positively to absolute performance? What factors contributed negatively to absolute performance? – Attribution – What factors had a positive influence on relative performance? What factors had a negative influence on relative performance? – Performance – Ranking of Performance: – Quartile – Time

INVESCO Asset Management Limited - Regulated by IMRO 25 Views from the Dark Side Product & Style Integrity Analysis – Marketing Proposition is “Multi-Product/Multi-Style” What is defined in the Mandate or Product Specification? Are we operating within the mandate? No “wiggle room”!

INVESCO Asset Management Limited - Regulated by IMRO 26 Views from the Dark Side Risk-adjusted Portfolio Analysis – Practical Application of Risk Specialisation Market Risk – Risk / Risk / Risk – Stress & Scenario Testing – Simulation » “What would be the impact on performance?” Credit Risk – Expected Loss » Loss Given Default – Unexpected Loss

INVESCO Asset Management Limited - Regulated by IMRO 27 Views from the Dark Side Risk-adjusted Portfolio Analysis (continued) – Practical Application of Risk Specialisation Volatility Analysis – Expected Volatility – Unexpected Volatility

INVESCO Asset Management Limited - Regulated by IMRO 28 Probability distribution of P&L's Probability Monthly Performance (%) % chance of unexpected loss -1.5% 5% chance of unexpected gain +3.0%

INVESCO Asset Management Limited - Regulated by IMRO Risk-Return -5% 5% 15% 25% 35% 45% 0%20%40%60%80%100%120%140% Risk (% Equity) Mean Return (% Equity)

INVESCO Asset Management Limited - Regulated by IMRO 30 Risk Appetite and Unexpected Volatility Risk (% Equity) Mean Return (% Equity)

INVESCO Asset Management Limited - Regulated by IMRO 31 Risk Adjusted Performance Measurement EL 99 % Base Probability Density Loss £m Base Case

INVESCO Asset Management Limited - Regulated by IMRO 32  EL  99 % Base New Profile Probability Density Loss £m Risk Adjusted Performance Measurement Adjusted Profile

INVESCO Asset Management Limited - Regulated by IMRO 33 Views from the Dark Side Investment Risk - the challenge: – To design and implement an approach to investment risk management that adds value to the global investment management process

INVESCO Asset Management Limited - Regulated by IMRO 34 Views from the Dark Side Investment Management - the challenge: – To deliver superior investment performance in a manner that is consistent with the mandate and/or expectations of our clients.

INVESCO Asset Management Limited - Regulated by IMRO 35 Views from the Dark Side At Invesco: “All we do is invest”

Views from the Dark Side Bill Martin - Global Head of Investment Risk GARP Risk Forum 19 December 2001