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Mitigating selection and operational risk on MAPs

For a firm like Lyxor, whose managed account platform is one of the largest and most successful in the industry – it currently hosts 107 single managers – staying on top of the risk management process is of paramount importance. It’s also a hugely focused operation, one that relies both on systems and people. This is understandable given that an enormous amount of work goes into screening managers before they are accepted onto the platform.

Mitigating selection risk is, therefore, a key element in Lyxor’s overall risk management process and involves a three-stage due diligence process according to Stefan Keller (pictured), Head of MAP Research & External Relations at Lyxor.

“We have a dedicated ten-strong hedge fund research and analysis team based in New York, London and Tokyo. Their job is classic investment due diligence and sourcing managers. They have to identify, evaluate, and monitor top-quality funds for our investment universe.

“This first layer – the search for talent – is critical. We look for early stage star managers through to the most highly regarded established managers in the business.”

“We want skilled managers who have succeeded in various market cycles. We want compelling investment strategies with attractive risk rewards. That often means that firms need to be transparent organisations, with a solid operational infrastructure and a solid internal organisation ideally using a team-based approach to investment management,” explains Keller.

Operational due diligence, the second layer, is handled by a dedicated team who belong to Lyxor’s risk department in New York and Paris. The team reviews all legal, financial, marketing documentation, conducts background checks on managers, and assesses business plans as well as talk to the COOs. There are five steps to this process:

1. Fund evolution and direction;

2. Key team and process assessment;

3. Documentation review;

4. Counterparty checks – confirmation of professional service relationships;

5. On-site visits – this is ongoing, all managers are visited at least once a year.

“As you can see we invest a big part of our resources in mitigating selection risk,” says Keller, who continues: “The third stage of the due diligence process is onboarding the manager. Here we define the trading limits, validated by Lyxor Risk department. These trading parameters are customised for each fund that joins our platform.”

Mitigating operational risk is just as important for Lyxor as mitigating selection risk. Not only are all assets segregated to ensure total control, and trade limits clearly defined and codified in an investment agreement – which Lyxor is then able to monitor on a daily basis – but oversight of the assets in each fund is implemented through the use of independent administrators.

“You need to build a risk framework that allows the manager to implement the strategy. We set a pre-defined level of risk at the onboarding stage but because this is customised for each fund the limits set are such that they allow the manager to fully implement the strategy.

“We have eight key parameters we use when monitoring managers: the instruments being traded; leverage levels; liquidity terms; Forex; sensitivity to market parameters; credit risk; concentration risk, and country risk,” confirms Keller.

The fact that it’s been over a decade since Lyxor took the initiative to remove a manager from the platform illustrates just how robust its risk management framework is. 

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