Views from the Dark Side Bill Martin - Global Head of Investment Risk

1. GARP/ISDA Risk Forum 19 December 2001 Views from the Dark SideBill Martin - Global Head of Investment Risk

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 ofthe Dark Side” • Darth Vader to Luke Skywalker – Star Wars IV

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!

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

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

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?

7. Views from the Dark Side • The big deal? O P M

8. Views from the Dark Side • The big deal?: Other People’s Money

9. Views from the Dark Side • What do they want?: • Performance • Absolute • Relative

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.

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

12. Macro research & asset allocation Micro research & stock/security selection Portfolio Construction Risk Management Performance Monitoring Views from the Dark Side • Global Investment Management Process:

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

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.

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.

16. Macro research & asset allocation Micro research & stock/security selection Portfolio Construction Risk Management Performance Monitoring Views from the Dark Side • Global Investment Management Process: Volatility Analysis “What if…” Buy List – Credit Risk Assessment

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.

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.

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.

20. Views from the Dark Side • Investment Risk – What is the end game? • To minimize the firm’s exposure to: • üUnexpected volatility of investment performance relative to mandate • üPersistence in investment underperformance • üLoss of client assets/Loss of growth in client assets • üLoss of revenue/Loss of growth in revenues • üLoss of capital

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

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

23. Views from the Dark Side • The design: GMAC GRMC Global Risk-Adjusted Performance Analysis (GRaPA) Local RMC Core Competencies Portfolio Construction Exception Reporting Investment Risk Policy (Minimum Standards) Contribution Attribution and Performance Assessment Product & Style Integrity Assessment Risk-adjusted Portfolio Analysis (Volatility Analysis; “What if” analysis) Investment Risk Managers 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.

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

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”!

26. Views from the Dark Side • Risk-adjusted Portfolio Analysis • Practical Application of Risk Specialisation • Market Risk • Value @ Risk / Assets @ Risk / Performance @ Risk • Stress & Scenario Testing • Simulation • “What would be the impact on performance?” • Credit Risk • Expected Loss • Loss Given Default • Unexpected Loss

27. Views from the Dark Side • Risk-adjusted Portfolio Analysis (continued) • Practical Application of Risk Specialisation • Volatility Analysis • Expected Volatility • Unexpected Volatility

28. -1.5% Probability distribution of P&L's Probability 5% chance of unexpected loss 5% chance of unexpected gain - 0 +3.0% + Monthly Performance (%)

29. Risk-Return 45% 35% Mean Return (% Equity) 25% 15% 5% 0% 20% 40% 60% 80% 100% 120% 140% -5% Risk (% Equity)

30. Risk Appetite and Unexpected Volatility Mean Return (% Equity) Risk (% Equity)

31. Risk Adjusted Performance Measurement Base Case Probability Density Base Loss £m EL 99 %

32. Risk Adjusted Performance Measurement Adjusted Profile Probability Density Base New Profile Loss £m D EL D 99 %

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

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.

35. Views from the Dark Side • At Invesco: “All we do is invest”

36. GARP Risk Forum 19 December 2001 Views from the Dark SideBill Martin - Global Head of Investment Risk