Boston-based asset manager Putnam Investments is at the vanguard of its industry’s risk managers. It has implemented a company-wide risk management system and launched a centralised financial engineering group

Just over a year ago, Putnam Investments set itself a dual task. First, it wanted to implement a risk management system that would give all types of users – from senior management down to portfolio designers and managers – access to the data and analytics they needed to make informed decisions. Second, Putnam was looking to assemble a group with in-depth financial engineering expertise to assist the company’s portfolio managers in using derivatives to enhance their investments and hedge their risks.

The firm recruited senior talent to spearhead these efforts. Last January it hired Richard Leibovitch from JP Morgan, as managing director and head of the new derivatives group. At JP Morgan, Leibovitch had been co-head of North American equity derivatives sales and trading. More recently, Putnam recruited Erwin Martens from Lehman Brothers, where he was head of global market risk management. Martens, a managing director, is now head of Putnam’s risk management efforts.

Putting the risk management system in place was complicated by the lack of off-the-shelf buy-side risk management solutions, especially for organisations as complex as Putnam. The company, which currently has $365 billion in assets under management, runs 60 mutual funds and a variety of other portfolios for institutional clients. The system needed to handle its existing assets and portfolio strategies, while being flexible enough to adapt to deal with new asset classes and investment approaches.

Putnam also sought a system that would support, rather than supplant, its existing technology, says Kevin Divney, senior vice-president and equity risk manager. As nothing in the market met its needs, Putnam teamed up with Barra, the California-based risk management technology company, to adapt its existing product for the investment management community. Putnam began rolling out the result – TotalRisk for Asset Management (TRAM) – early last year.

The TRAM system allows Putnam to tie together all its existing analytical expertise and data, some of which had previously accumulated within individual portfolios or groups and was not therefore readily available throughout the firm. The TRAM system gives each employee who is charged with some form of risk/return optimisation task access to all the relevant data. “All the system’s analytics feed the decision-making process,” says Martens.

The TRAM system works with the existing systems to gather and disseminate risk information. It uses traditional risk measures such as value-at-risk and quantifies them in a variety of ways, both in absolute and relative terms. “There is a lot of flexibility in how the data are delivered,” Divney says. This accommodates a range of uses, such as risk/return benchmarking, as well as different portfolio strategies and styles.

TRAM provides a common basis for performance and risk comparison of Putnam’s various portfolios and asset types. Steve Oristaglio, senior managing director and deputy head of investments, says: “The different groups already had sound risk management capabilities, but now we can compare the different funds on an apples-to-apples basis, and we can aggregate the information up to the firm level.”

While the system has not radically changed the firm’s core risk management approach, it has acted as a catalyst for new ideas. According to Martens: “It’s like a giant brainstorming session.” The transparency it brings to Putnam’s risk posture allows portfolio designers and managers to identify exposures to uncompensated risk and generate responses, Divney says.

The system also has state-of-the-art analytics, developed by both Putnam and Barra, that allow the user to decompose portfolio risk. “It can break our risks into common factors and specific factors,” says Leibovitch. Once this is done, the firm can decide how and to what extent it should hedge each factor.

Meanwhile, Putnam’s new financial engineering group has grown to 16 professionals. “We felt that, while we have developed skills in portfolio design and portfolio modelling, we really had to build out our risk management and derivatives capabilities,” Oristaglio says.

The financial engineering group helps portfolio management teams – which often have their own dedicated derivative strategists – tailor derivative solutions to specific problems. After the risk management team frames the issues for each of the funds, the financial engineering team works to solve them.

The company’s growing derivatives expertise allows Putnam’s portfolio managers to go beyond the limits of their more traditional tools. For example, they can now use total return swaps to gain exposure to overseas markets where the cash markets are illiquid or inefficient. They can manage spread risk on corporate bonds with interest rate swaps, rather than by selling the positions. Or they might pursue asset swap opportunities and relative value trades, Leibovitch says. The financial engineering team recently hired a credit derivative expert. This gives it the ability to evaluate, for example, credit derivative-based securitisation solutions as an alternative to liquidating part of a portfolio.

Putnam’s risk management expertise will be useful in its plans to expand into alternative asset classes. Through its association with Boston buyout firm Thomas Lee Partners, Putnam plans to roll out a number of hedge funds in 2000. Although the fund profiles are still under consideration, the company is considering strategies that include global macro, public/private equity, mortgage-backed and long/short equity, says Oristaglio.

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