Inside BlackRock’s risk management framework

In today’s changing environment, adaptability and evolution is key. In this spirit, Kristen Walters, Managing Director, Risk & Quantitative Analysis Group at BlackRock, shares what happens inside BlackRock and how the risk management team is adapting to the evolving need for their expertise.

BlackRock’s 1988 founding was profoundly impacted by the stock market crash of 1987, where management had first-hand experiences dealing with an inadequate understanding of risk. Since inception, BlackRock has sought to protect the firm and clients from similar experiences and risk management has remained a core part of BlackRock’s culture.

Risk management framework

Given the importance of risk management, BlackRock purposefully built a risk framework that touches all aspects of the organisation. The process starts at the top – with the board of directors – and includes many governance committees that look after key risks in the firm. As primary risk owners, BlackRock’s investment businesses take responsibility for managing and mitigating risk and are considered the “first line of defence” for risk management. BlackRock has a number of independent risk and control functions, including the Risk and Quantitative Analysis (RQA) team that measures and manages risk based on the controls put in place by primary risk owners, as well as Compliance and Financial Controls. In this capacity, RQA, Compliance and Financial Controls are known as the “second line of defence”. Finally, internal audit is relied on as a “third line of defence” to substantiate and evidence that businesses are effectively addressing risk and control issues.

Risk managers identify and manage investment, counterparty, operational, technology, model, third party and regulatory risks across the firm. Partnering with the firm’s technologists, risk managers develop analytics and standards for firm-wide investment risk and performance measurement, leveraging the capabilities of Aladdin, BlackRock’s trading and risk management system.

Mission of risk management

BlackRock’s risk management team has a dual mission, to provide independent risk oversight to manage fiduciary and enterprise risks and to provide advisory and consultative advice to investment teams.

Managing risk requires building close partnerships with investors. Structurally, BlackRock’s risk management team is independent of investment businesses, allowing risk managers to provide an unbiased perspective while working closely with investors.

Risk managers promote a culture of constructive challenge when interacting with investors. The goal is to develop high challenge and high trust relationships that result in innovation in portfolio construction and management. And, to ensure constant communication between risk managers and risk takers, risk managers are co-located with investors globally.

BlackRock’s investment philosophy is based on being “risk aware”, with risk management as an integral part of the investment process. Risk managers partner with investment businesses to help investors build risk aware portfolios by advising on portfolio construction, hedging strategies and quantitative aspects of managing risk and return.

Risk management does not mean risk avoidance – risk managers must ensure that risk is aligned with client objectives. By providing an independent and trusted perspective, risk managers help ensure risks are properly understood and appropriately managed for clients. People take risks, not computers or algorithms, so it is important for risk managers to work together with investors and traders.

Additionally, risk managers must have significant subject matter expertise to understand investment processes and properly identify and articulate exposures. By partnering with investors, risk management seeks to ensure risk taking is deliberate, diversified and scaled.

To measure and manage risk across the $6.8T that BlackRock manages on behalf of clients (as of Q2 2019), BlackRock’s five pillar “Investment Risk Paradigm” provides a consistent framework for managing risk across investment businesses.

The first pillar, ex-ante risk measurement, reflects how risk managers use risk measurement tools to provide accurate and appropriate risk measures across investment, liquidity, credit and redemption risk. Leveraging proprietary factor models, risk managers measure risk in portfolios, including decomposing risk on an ex-ante basis.

The second pillar, risk management, details how risk managers work with investors to determine appropriate levels of risk for each fund and ensure risk taking is consistent with established targets. Objectives are agreed with clients and understood across BlackRock to maximise the ability to meet or exceed client expectations.

The third pillar, portfolio manager risk and return awareness, references how risk managers meet with investors regularly to discuss risk positioning, including evaluating behavioural aspects of investing, such as decision-making biases and performance impacts. Risk managers meet with investors to review risk levels relative to market conditions and outlook.

The fourth pillar, performance attribution, outlines how risk managers determine the degree of consistency and accuracy between intended bets and actual fund performance. Risk managers leverage tools to decompose risk contributions across a number of different metrics.

Finally, the fifth pillar, performance analysis, is where risk managers review the performance of each fund relative to the benchmark, peers, and comparable accounts. BlackRock’s Chief Performance Officer provides regular reporting to senior management and an objective view of the firm’s investment performance.

Just as BlackRock’s risk function has adapted since inception, BlackRock’s risk management framework continues to evolve to meet the everchanging needs of clients, growing market complexity, regulation and product innovations.