In December I had the pleasure of moderating a panel of leading private equity risk managers and LPs on the subject of ‘What role for risk management in private equity?’ at the Said Oxford Risk Symposium, hosted by LDS Partners.
Asked to describe private equity risk management, my five panelists provided six definitions, which sums up nicely the state of risk management in the industry. Despite the maturity of the private equity industry in many ways, risk management remains an amazingly idiosyncratic activity between managers.
Should risk officers concern themselves with individual investments or only the portfolio level? The majority thought the latter, but not unanimously so. Should risk be defined as the risk of losing money, or the risk of not achieving a firm’s stated return objectives? Losing money will kill a firm fast. But not hitting returns could mean a slow death.
Meanwhile, do mathematical approaches typical of financial market risk management lend themselves well to private equity risk management, where data is so much scarcer. And what about firm-wide risks, such as operating models of taxation or cyber-risk? For some these risks aren’t on the radar, for others they are seen as core.
For small firms doing a small number of small deals, the idiosyncratic risk of individual private company investment does indeed seem easy to diversify away. But most private equity activity is undertaken in an increasingly competitive and institutional context. The old-school view of a private equity risk function, remote from the business of making investments, a compliance burden to comfort regulators or a tick in the box for demanding LPs, always seemed complacent. When you live in a world that seems permanently on the verge of a financial crisis, with extreme monetary policy the norm and hacking of the private sector a standard machinery of state, it seems reckless.
Meanwhile, for many LPs and for a long time, private equity risk management has not been worth the bother. But private equity is now the largest alternative exposure for pension funds after real estate. For how much longer can PE risk be swept aside as an oddity that just doesn’t fit our models.
With everyone focused on value-add in the front –office, I can’t help but wonder if the long-term winners over the coming decades will be decided far from the cut and thrust of deals.
The panelists were: Laurent Braun, Head of Operations Risk Management, European Investment Fund; Andrew Freeman, Chief Risk Officer, Ardian; Philippe Jost, Senior Vice President, Capital Dynamics; Alan Picone, MD, Global Head of Risk & Management Company Solutions, Duff & Phelps, John Renkema, Senior Portfolio Manager Private Equity, APG.