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Stone House Consulting, LLC 
Succinct and effective article. The picture communicates even better! Operational risk is also magnified by outsourcing and complacency regarding those vendors.
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Many thanks, Zane! And you hit the nail on the head vis-a-vis some of the concerns around outsourcing. We address some of that in upcoming articles including the next one, “The Blind Leading the Blind.”
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I like the real-world “spelling mistakes” reference; the “4-eyes approach” is always best. Keep up the quality in this series.
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Thanks, Kevin!
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Great article Holly! I look forward to reading the rest of the series.
Sunil
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Thanks, Sunil! We are having a lot of fun writing them!
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Avoiding complacency, hiring competent associates and listening to staff feedback can certainly helped to mitigate operational risk. But, these tend to be passive solutions. A powerful approach is to utilize senior-level cross-functional teams with representatives from the middle office, accouting, compliance, IT and, perhaps, even the front office. A forum such as this provides an active arena to identify operational risks, share potential solutions, create a process for follow-through and accountability. In addition, risk can often be magnified through redundant operations or gaps in processes – these are more evident when analyzed across an organization.
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Holly, I appreciate that the Stone House team is putting this together.
As a variation of Operational Risk, I hope you will also address Model Risk, i.e. Are reported evaluations seriously misleading the investment staff?
The particular performance model issues that I have found firms to be most dangerously complacent about are:
1. Is the calculation of the return of components of portfolios robust even when there is intra day trading? Or does it break down in extreme cases, indicting that it is unreliable in all cases, especially when there are no clear intuitions to flag problems. All versions of modified Dietz and IRR, when applied to issues or sectors on a single day in which there are any intra day trades, are defective in this way but many seem to blithely employ them nonetheless.
2. Is leverage consistently and sensibly addressed in all performance, attribution and risk reports? For example, does the manner in which one calculates the return of a short of IBM in a fund on a day allow it to be meaningfully linked with the returns of IBM on days that the fund is long this issue?
3. What precise economic question is a fixed income attribute like shift or twist of the yield curve (changes that are not controllable by the firm) supposed to answer? And is it parallel, compatible and coherently includable in the same attribution model with the precise economic questions that allocation and selection (decisions that are controllable by the firm) are supposed to answer?
4. Are balanced, currency and risk attribution addressed at all and in a way that is meaningfully consistent with the other attribution analysis employed?
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Holly – an excellent series of articles. Firms can no longer take the “if it’s not broke, don’t fix it” mentality when it comes to operational risk and need to hire forward thinking COOs and CROs. Here is an interesting article about how operational risk is an overlooked necessity: http://tinyurl.com/2aojg2s
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