The Edhec Business School has embarked upon the creation of a joint venture with the consultancy firm, “Risk Advisory Solutions”, that will offer a range of services to the financial industry in order to address the future challenges with regards to risk management. What is the context of this initiative?

Jean-René Giraud: The creation of Edhec-Risk Advisory directly results from the analysis of the main findings of the first “Edhec European Asset Management Practices Survey”. This survey, conducted in the summer of 2002 and published in March 2003, has depicted a series of core issues that the industry will have to deal with over the coming years.

If it is true and widely recognised that the asset management industry is going through a severe economic crisis due to the diminution of assets under management, pressure on management fees and the absence of efficient management of their cost base, these difficulties are even less well accepted in that the value propositions of the industry are being challenged by investors. On the one hand, the industry is reaching the limits of the commercial offerings that are widely publicised and that favour management objectives too close to indices, where high management fees and high portfolio turnover costs do not find a natural justification in light of the mediocre returns offered. Moreover, the industry has not yet widely embraced the broad possibilities offered by management techniques based on derivatives that enable products to be built with different risk profiles.

On the other hand, the alternative management industry that leads the innovation race has not yet solved the numerous issues that are limiting its generalisation, such as the lack of a recognised regulatory framework, high management costs and high levels of extreme risk such as option risk, volatility risk, liquidity or operational risk.

As a result, more than simply consolidation, the natural consequence of over-fragmentation and tight economic times, the industry is facing a complete reshaping and has to re-invent itself dramatically.

What is the industry model asset managers are likely to converge to?

Jean-René Giraud: Rather than following the traditional active vs. passive segmentation, we believe the industry will converge towards a model closer to the reality of the management process. It seems clear that the consolidation is following the core-satellite model where asset managers might either position themselves on the one hand as providers of tracker funds, products with low margins but very large economies of scale or, on the other hand as producers of extremely actively managed funds for which higher management fees, if not linked to performance, make sense. This model, however, also requires the emergence of a third party, assembling the various components available on the market and in charge of strategic allocation, selecting the providers, as well as conducting risk and performance monitoring on behalf of the final investor. In this context, it becomes clear that these asset managers, and their various service providers, will have to establish clear differentiating capabilities such as the capacity of managing risk on an industrial basis.

Additionally, recent regulatory changes such as UCITS III, the European Capital Adequacy rule and the revision of the European Investment Services Directive, represent major factors that need to be considered by asset managers in the context of a tight economical situation and fierce competition with Investment Banks, much more advanced in the art of managing these challenges.

In more detail, what is the nature of these challenges?

Jean-René Giraud: The risk management discipline is moving onto the agenda of investment managers who have very recently started investing in the infrastructure required to support a risk-aware organisation. More commercial offerings are structured around the specific risk profiles of the product ranges (structured products, asymmetric risk profiles, etc).

These structural changes are not minor as they will affect all levels of the organisation, from governance, to organisation and operations, and will require the implementation of more complex information technology. These changes will be even more brutal in that the regulator is closely monitoring the developments happening in the industry and driving the change through new legislation.

But the fundamental question for asset managers will be the strategic choices they will make with regards to implementation. Solutions developed in the risk management discipline are not always mature and the difficult balance between the disciplined mathematical frameworks and pragmatic operational solutions will be hard to achieve.

Edhec-Risk Advisory has been created to respond to this need and to provide a blend of operational and industry expertise mixed with the appropriate level of academic and research input. We are offering a range of services that covers all types of risk, from market to operational through to liquidity risks, supporting the resolution of regulatory, organisational and operational, as well as technological challenges.

Can you tell us more about your target customers?

Jean-René Giraud: Our offerings are targeted at the asset management industry in its widest definition. This does include pure institutional and retail asset managers, but also hedge funds, pension funds, insurance companies and private banks as well as their main service providers such as brokers, custodians, administrators and transfer agents who wish to transform their service offerings.

Most challenges of the industry happen to be at European level (from regulatory to competition). We are therefore positioning ourselves as service providers on a European basis. With offices in Paris, London, Lille and Nice, the Edhec Group is building a true European capability that supports this strategy.

What about the timing of this initiative?

Jean-René Giraud: Timing is key in the advisory industry. Even though the buy-side might have required our services two years ago, we did not believe at that stage that asset managers had already made their minds up on the question of developing their risk management capabilities. The economic climate has also proven to be extremely delicate for service providers. We have recently observed some clear signals in the industry that asset managers are now ready to re-start building capabilities after a couple of years of cost cutting. This makes perfect sense to us in a context where investors are now starting to consider various investments again following the large desertion of equity markets that recent market adjustments resulted in.

What will Edhec-Risk Advisory bring to its clients that they will not find with the numerous existing advisory firms who have developed risk practices?

Jean-René Giraud: Under the new economic conditions, asset managers do not intend to use advisors anymore in replacement of staff, as an adjustment variable to fixed costs, but merely to call in advisors that will bring and transfer expertise on the very specific questions that pave the risk management discipline.

Our clear differentiation factor lies in the fact that we have combined academic, research and industrial expertise in a discipline that requires high levels of focus. By nature, we are involved in the very early stages of research into the various issues related to risk management and are accompanying our clients in the development and implementation of solutions in a true industrial environment.

The foundations of Edhec-Risk Advisory are built on three founding principles:

• Pragmatism in the search for solutions to implement adequate changes in the governance, organisation and system;

• Selection of unique international expertise in the quantitative and qualitative risk management disciplines;

• Development of synergies between the academic and research expertise of Edhec with the professional experience of industry consultants.

These principles allow Edhec-Risk Advisory to offer a competitive portfolio of services that suits the current needs of investment managers and their service providers.

* Jean-René Giraud is C.E.O. of Edhec-Risk Advisory. He was formerly Managing Principal at CAPCO and focuses on risk management issues for the institutional investment management industry. Jean-René is the author of several articles on alternative investments, specifically on operational models for prime brokers and hedge funds.