BOOK REVIEW: Conversational guide to investment portfolios
Author tackles risk without pages of mathematical proofs
Portfolio Representations: A Step-by-step Guide to Representing Value, Exposure, and Risk for Fixed Income, Equity, FX, and Derivatives, by Jem Tugwell, Harriman House, Ltd., 473 pp.
Reviewed by Matthew Boutte, vice-president and assistant treasurer, Iberia Bank, $11.7 billion-assets, Lafayette, La.
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One of the hardest things for a banker to do is communicate the various risks in the investment portfolio to people who don?t do this for a living.
For example, how do you distill and communicate investment risks to your board?
The second hardest thing, likely, is convincing regulators that you do, in fact, understand the risks you?ve assumed; that they?re within your risk tolerances; and that you have them under control.
Fortunately, Jem Tugwell?s Portfolio Representations does a good job of explaining how to break down these risks into their individual components, and then reassemble them in a format that simplifies the communication of risk exposures and that provides a logical format for portfolio presentations.
Overall, Portfolio Representations is a thoughtful look at the components of risk embedded in our investment portfolios. It provides a technique to break those risks into digestible bites, allowing for a better understanding and communication of our exposures.
Good guide to critical investment categories
Portfolio Representations is organized by asset class with sections on equity, money market, fixed income, currencies, and funds. A broad overview of each investment type is presented, along with the highlights of the asset class, its pricing, and its component risks. The book is broken down further within each chapter, digging into the nuances of each class such as government bonds, zero coupon bonds, mortgage-backed securities, and interest-rate swaps. The book isn?t directed strictly towards bankers, so some of the asset classes probably won?t be of interest, but the chapters on money-market and fixed-income investments are quite good and worthy of your attention.
In the author?s words?
?The credit crunch provided the asset management community with a brutal reminder of the importance of having genuine knowledge of portfolio structures and the risks embedded within them. More so than ever, fund managers need a clear and consistent way of separating value from exposure in their portfolios, allowing a complete ?look-through? to the real risks contained in derivatives and pooled/structured products.?
Each individual section discusses the various characteristics and risks of the investment type in question and presents a potential table for the illustration of these risks on a ?line-item? basis. Each risk factor is explained in detail but is done so in a largely qualitative way, rather than a quantitative one, and where possible, builds on the risk factors examined in earlier sections.
For example, the explanation of Macaulay duration leads to the discussion of modified duration. Modified duration leads to effective duration. Effective duration leads to an explanation of convexity. This allows Tugwell to engage in reasonably thorough discussions of most risk factors without pages and pages of mathematical proofs. Additionally, it?s all presented in a conversational way that provides a useful framework for any discussions you may need to have with your non-financial constituents.
The process of building on prior examples is also used in what Tugwell refers to as the ?exposure view.? He uses this technique to add additional risk exposure onto a line-item presentation of an investment. The exposure view isn?t all that different from what you probably already use for your investment portfolios, but his approach is useful in looking at the various risks within each item.
In addition, the real value is in the discussion of each type of risk, its components, and how it relates to the other risks in the investment.
Two sides of the coin
It?s rare that we get a chance to think about the inter-relationships of the investment portfolio risks that we?re managing and the book does a good job of bringing those risks to the fore. Also included is a discussion of how to price each investment type, including the intuition behind the formulas. All of this fits nicely with the risk exposure discussion, since it?s really two sides of the same coin.
The only criticisms I would level at Portfolio Representations are that many of the asset classes reviewed in the book are probably not appropriate in bank portfolios and so, for bankers, the book contains some wasted information. Secondarily, all of the examples in the book are either in Euros or pounds. I found that a little awkward at times, but it wasn?t a serious problem.
To be sure, our current climate is producing ever-increasing scrutiny on the identification and management of risk exposures. Jem Tugwell has written a book that clears away some of the fog and for that reason, it?s worth your time.
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