1. Can you tell us a bit about your background?
David X. Martin is Senior Vice President for AllianceBernstein, which as more than $450 billion in assets under management. Formerly Chief Risk Officer at AllianceBernstein, he also has held senior risk management positions at Citibank. Martin was founding Chairman of the Investment Company Institute’s (ICI) Risk Committee and is an adjunct professor at New York University Graduate School of Business. He has written articles for The Bankers Magazine, the journal Pension & Investments, and the AEI-Brookings Joint Center website. He and his family live in the greater New York metropolitan area. He recently wroteRisk and the Smart Investor
2. How do you think your background in risk management helped you understand risk and reduce your company’s exposure to it?
As a veteran of both the Latin America debt crisis in the 1980’s and the Asian financial crisis in the mid 1990’s, I felt a familiar chill down my spine as the storm winds began to swirl around Lehman Brothers.
3. What inspired you to write a book?
When I first told my family, friends and colleagues I wanted to write a book, they all asked me the same thing: Why? You’ve had great success in your career, and what’s more, you’re one of the busiest men we know. Why go to the trouble?
My answer was simple. Every person goes through life carrying a satchel. You put things into it for years, and then one day the time comes to start taking things out, and sharing them with others. Risk management is one of the things in my satchel. I’ve been involved in the financial services industry for nearly 35 years, and have remained on my feet through a variety of domestic and global financial crises. Now, I feel that the time has come to share what I’ve learned with those who want to improve their decision making and risk management – that is, to improve the quality of their lives – but don’t have the proper tools.
4. I know it is hard to define risk but if you could define it in a short way how would you?
Risk is uncertainty
5. The definition of risk has evolved over the past few decades (at least in Academia) is it possible to precisely determine risk that will not change in the future as well?
Risk exists because of one simple fact: Decisions are always based on incomplete information. The measurement of risk will become better over time but will never be complete.
6. What are your thoughts on VaR and the role it played in the financial crisis?
VaR is the amount of money a specific investment can lose in a single day. Traditionally used to measure the value at risk on discrete transactions, it has now begun to be applied across entire portfolios. It’s strength is that it is easily calculated. It’s weakness, if it has one, is that it is based on historical loss data, which do not necessarily reflect current conditions. For that reason it can provide you—and regulators, I might add—with a false sense of security. VaR is also a poor indicator during extreme events—it tells you the best likely outcome, not the worst.
7. Do you agree with Nassem Taleb that it is impossible to foresee all future risks, or would you disagree with the statement?
I think there is a difference between known, unknowns and unknown unknowns. In other words, sometimes you know what you don’t know because of say, incomplete information but there are times that you just don’t know what can derail you. So I would agree with Nassem Taleb.
8. You talk about two characters in your book Rob and Max, can you tell us more about them?
Max reflects many of my own life experiences. Rob grew out of specific people and situations and some imagination on my part. My purpose was solely to make the risk principles become understandable and add some levity to a topic that sometimes can be very boring.
9. How much does an investor’s self control have to do with their ability to minimize risk?
Discipline and process are extremely important elements to managing risk. It’s not about coming up with a great idea while taking a shower in the morning, rather it is all about doing the right things every day.
10. What role does liquidity play in risk management?
Liquidity, naturally enough, can be thought of in terms of water, and to understand the consequences of the loss of liquidity one need only think of ice. Yes, it’s water, but it no longer flows. During the crisis, when the markets for certain financial instruments froze, so did the ability of financial institutions to sell other assets to raise cash to cover their liabilities, thus leading to liquidity risk.
11. How different is risk management for an individual as opposed to an institution, especially a large one?
Institutions think of risk relative to comparative benchmarks. So for example, if the market is down 20% and the portfolio returned 10%, the institution has added 10% Alpha, or more simply put, their performance was excellent. Individuals cannot live on or eat relative negative performance. However, the approach in terms of guiding principles and process are all too similar which is really the thesis of my book.
12. Have we learned from the crisis, and is there any way institutions can manage risk to guarantee this crisis does not occur again?
Risk based capital has not worked and no institution can guarantee this crisis will not occur again. I do think we have learned from the crisis but I do not think the next crisis will stem from the same causes.
13. On a similar note do you think the recent passage of financial reform addresses the above concerns?
It’s almost like we are solving for the last problem, not the next one. For example, the next crisis could stem from an information security breach, i.e. banks cannot verify where payments are sent because of a cyber problem.
14. I am curious specifically to know if you have any recommendations on how the credit agencies can do a better job at evaluating pools of mortgages and their chance of default. Can the obvious conflict of interest ever be eliminated or even minimized?
I asked a senior executive of a major credit agency how they got it so wrong. He said, “We never thought real estate would go down”. What went wrong was their ability to assess risk, not the conflicts of interests that people worry about.
15. Do you plan on writing more books in the future and if so what it be related to risk or a different topic?
I have another book on risk inside me. The topic will be that risk is always present but you need to embrace it to be successful.
16. Value investors seem to have a different definition of risk then most of the investment world. If the market declines 20% and stock X declines 50% a believer in the efficient market theory will say the stock is more volatile and therefore more risky, whereas a value investor might see a bargain in the stock and say the stock is less risky now. What is your take on the matter?
Value investors look for value. So when stocks are cheap, they see value. Of course the risk is that their assessment of value is wrong and the price drops lower.
The best value investors have great research and although you can never call the bottom, they recognize value and are rewarded over time.
To purchase the book on Amazon.com click on the following link: Risk and the Smart Investor
To check out David's blog visit- http://www.davidxmartin.com/
Disclosure: I have a material connection because I received a free copy of this book from the publisher. In addition I receive a small commission if you click on the above link and buy the book (or anything else) from Amazon.com It does not cost you a penny more. So I get a commission, Amazon gets a sale, and you get your book so it is a win for everyone.
David X. Martin is Senior Vice President for AllianceBernstein, which as more than $450 billion in assets under management. Formerly Chief Risk Officer at AllianceBernstein, he also has held senior risk management positions at Citibank. Martin was founding Chairman of the Investment Company Institute’s (ICI) Risk Committee and is an adjunct professor at New York University Graduate School of Business. He has written articles for The Bankers Magazine, the journal Pension & Investments, and the AEI-Brookings Joint Center website. He and his family live in the greater New York metropolitan area. He recently wroteRisk and the Smart Investor
2. How do you think your background in risk management helped you understand risk and reduce your company’s exposure to it?
As a veteran of both the Latin America debt crisis in the 1980’s and the Asian financial crisis in the mid 1990’s, I felt a familiar chill down my spine as the storm winds began to swirl around Lehman Brothers.
3. What inspired you to write a book?
When I first told my family, friends and colleagues I wanted to write a book, they all asked me the same thing: Why? You’ve had great success in your career, and what’s more, you’re one of the busiest men we know. Why go to the trouble?
My answer was simple. Every person goes through life carrying a satchel. You put things into it for years, and then one day the time comes to start taking things out, and sharing them with others. Risk management is one of the things in my satchel. I’ve been involved in the financial services industry for nearly 35 years, and have remained on my feet through a variety of domestic and global financial crises. Now, I feel that the time has come to share what I’ve learned with those who want to improve their decision making and risk management – that is, to improve the quality of their lives – but don’t have the proper tools.
4. I know it is hard to define risk but if you could define it in a short way how would you?
Risk is uncertainty
5. The definition of risk has evolved over the past few decades (at least in Academia) is it possible to precisely determine risk that will not change in the future as well?
Risk exists because of one simple fact: Decisions are always based on incomplete information. The measurement of risk will become better over time but will never be complete.
6. What are your thoughts on VaR and the role it played in the financial crisis?
VaR is the amount of money a specific investment can lose in a single day. Traditionally used to measure the value at risk on discrete transactions, it has now begun to be applied across entire portfolios. It’s strength is that it is easily calculated. It’s weakness, if it has one, is that it is based on historical loss data, which do not necessarily reflect current conditions. For that reason it can provide you—and regulators, I might add—with a false sense of security. VaR is also a poor indicator during extreme events—it tells you the best likely outcome, not the worst.
7. Do you agree with Nassem Taleb that it is impossible to foresee all future risks, or would you disagree with the statement?
I think there is a difference between known, unknowns and unknown unknowns. In other words, sometimes you know what you don’t know because of say, incomplete information but there are times that you just don’t know what can derail you. So I would agree with Nassem Taleb.
8. You talk about two characters in your book Rob and Max, can you tell us more about them?
Max reflects many of my own life experiences. Rob grew out of specific people and situations and some imagination on my part. My purpose was solely to make the risk principles become understandable and add some levity to a topic that sometimes can be very boring.
9. How much does an investor’s self control have to do with their ability to minimize risk?
Discipline and process are extremely important elements to managing risk. It’s not about coming up with a great idea while taking a shower in the morning, rather it is all about doing the right things every day.
10. What role does liquidity play in risk management?
Liquidity, naturally enough, can be thought of in terms of water, and to understand the consequences of the loss of liquidity one need only think of ice. Yes, it’s water, but it no longer flows. During the crisis, when the markets for certain financial instruments froze, so did the ability of financial institutions to sell other assets to raise cash to cover their liabilities, thus leading to liquidity risk.
11. How different is risk management for an individual as opposed to an institution, especially a large one?
Institutions think of risk relative to comparative benchmarks. So for example, if the market is down 20% and the portfolio returned 10%, the institution has added 10% Alpha, or more simply put, their performance was excellent. Individuals cannot live on or eat relative negative performance. However, the approach in terms of guiding principles and process are all too similar which is really the thesis of my book.
12. Have we learned from the crisis, and is there any way institutions can manage risk to guarantee this crisis does not occur again?
Risk based capital has not worked and no institution can guarantee this crisis will not occur again. I do think we have learned from the crisis but I do not think the next crisis will stem from the same causes.
13. On a similar note do you think the recent passage of financial reform addresses the above concerns?
It’s almost like we are solving for the last problem, not the next one. For example, the next crisis could stem from an information security breach, i.e. banks cannot verify where payments are sent because of a cyber problem.
14. I am curious specifically to know if you have any recommendations on how the credit agencies can do a better job at evaluating pools of mortgages and their chance of default. Can the obvious conflict of interest ever be eliminated or even minimized?
I asked a senior executive of a major credit agency how they got it so wrong. He said, “We never thought real estate would go down”. What went wrong was their ability to assess risk, not the conflicts of interests that people worry about.
15. Do you plan on writing more books in the future and if so what it be related to risk or a different topic?
I have another book on risk inside me. The topic will be that risk is always present but you need to embrace it to be successful.
16. Value investors seem to have a different definition of risk then most of the investment world. If the market declines 20% and stock X declines 50% a believer in the efficient market theory will say the stock is more volatile and therefore more risky, whereas a value investor might see a bargain in the stock and say the stock is less risky now. What is your take on the matter?
Value investors look for value. So when stocks are cheap, they see value. Of course the risk is that their assessment of value is wrong and the price drops lower.
The best value investors have great research and although you can never call the bottom, they recognize value and are rewarded over time.
To purchase the book on Amazon.com click on the following link: Risk and the Smart Investor
To check out David's blog visit- http://www.davidxmartin.com/
Disclosure: I have a material connection because I received a free copy of this book from the publisher. In addition I receive a small commission if you click on the above link and buy the book (or anything else) from Amazon.com It does not cost you a penny more. So I get a commission, Amazon gets a sale, and you get your book so it is a win for everyone.
