Strategic Risk Management

CHAPTER 6Man versus Machine

INTRODUCTION

In the first five chapters, we detailed the tools necessary to implement a holistic approach to risk management. All of the tools are quantitative. It is reasonable at this point to push the analysis further. Is it more likely that managers who use systematic or algorithm-driven investment strategies have different return-risk profiles than managers that rely on discretionary techniques? How widespread is the use of quantitative techniques in discretionary asset management? Is there a difference in risk exposures to well-known factors across discretionary and systematic funds by category?¹

In addition, so far we have taken a broad view of risk—mainly from a portfolio point of view (i.e., portfolio volatility and portfolio downside risk). However, what are the drivers of these risk exposures? We explore a number of systematic risk factors and compare the exposures of systematic and discretionary managers. Discretionary managers rely on human skills to interpret new information and make day-to-day investment decisions. Systematic managers, on the other hand, use strategies that are rules-based and implemented by a computer, with little or no daily human intervention. How does this difference play out on the risk dimension?

In our experience, some allocators to hedge funds, including some of the largest in the world, either partially or entirely avoid allocating to systematic funds. The reasons we have heard for this include: systematic ...