Cornell University Johnson at Cornell University

Business Roundtable

The Business of Asset Management

The Johnson School took its "Business of ..." series to New York City on Jan. 17, 2008, for the Business of Asset Management, hosted by Morgan Stanley and co-sponsored by the Johnson Club of New York. The event brought together three panelists, each with a unique perspective, to discuss asset management. Sanjeev Bhojraj, associate professor of accounting and faculty director of the Parker Center for Investment Research, moderated the panel. Discussion topics were determined by questions from an audience of more than 100, including alumni, faculty, and current and prospective students.

Many of the questions focused on the August 2007 crisis attributed to the collapse of investments in subprime mortgages. Before the downward spiral, investment managers, flush with liquidity and the means to borrow to finance investments, aggressively sought investments at all risk levels—including subprime mortgage packages.

"There's no doubt that liquidity drove excesses in the housing market," said Maureen McGrath, MBA '84, managing director and senior analyst in equity research at Newberger Berman, a division of Lehman Brothers. "We need to unwind all of this, but it is controlled."

The Business of Asset Management panelists The Business of Asset Management panelists (left to right): Michael Graves, Maureen McGrath, MBA '84, and Edward Reilly, MBA '06

Edward A. Reilly, MBA '06, also identified ready liquidity and over-borrowing to purchase investments as sources of the summer meltdown. As a vice president at Morgan Stanley, Reilly headed a newly formed fixed-income proprietary trading group that went live at the firm in early 2007. As the year progressed, "I had that queasy feeling – guys with too much money were chasing any deal," Reilly said. "People were overly comfortable with risk, and no one cared about fundamentals."

Audience members had a number of questions for Michael Graves, managing director of Swiss Re. As head of a team that runs a global portfolio of automated strategies based on quantitative models, Graves brought a completely different perspective to market fall-out from the subprime collapse and the future of quantitative investing. When asked where quantitative models broke down in summer 2007, Graves pointed to overly optimistic bond ratings—in other words, poor data and excess liquidity.

Did quantitative models capture the risk of investments in subprime mortgage products, or was the August 2007 market crisis what statisticians call a "big deviation event?"

"You can calculate this stuff, but you can never predict when it will happen," said Graves. "Human psychology played a big part, but liquidity is what drove it."

Even with markets appearing uneasy and volatile at the start of 2008, the panelists were willing to make some projections for the future. "Alphas will be 20 percent to 30 percent higher," said Graves, referring to the often-used measure of performance on a risk-adjusted basis.

Morgan Stanley's Reilly expects to see continued "herding" among investment managers, as they actively mimic the moves of competitors. Researchers see herding as way to control risk and preserve funds under management, while some use the term to describe portfolio managers charging into stocks without adequate review of fundamentals. Yet for the savvy portfolio manager, "volatility gives opportunity," said Reilly.

"Everything is an investment horizon issue," concluded moderator Bhojraj. To profit from volatility, one must choose the right horizon, be it a minute, hour, or day.

– Shannon Dortch

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