Question Details
(Answered)-Read the case "J.P. Morgan Private Bank". Answer the following
Read?the case "J.P. Morgan Private Bank". Answer the following questions and provide a critical?discussion in support of your answers:
(1) Would you recommend that?Georgiy?Zhpkharev?be moved from his current role as a risk advisor to the portfolio management team to become part of the risk management team as the manager responsible for risk management?
(2) Could?Morgan's risk management model have worked for AIG?s Financial Products?
Please do not restate information. Please evaluate?the two questions based on the information flows in the case. 3pages
9-311-003
REV: SEPTEMBER 28, 2010
ANETTE MIKES
CLAYTON S. ROSE
ALDO SESIA JR.
J.P. Morgan Priv
vate Ban
nk: Rissk Man
nagemeent
durring the Finan
ncial Crrisis 20008-20099
n Erdoes (MB
BA 1993), the chief executtive officer off JP Morgan Chase?s (Mo
organ)
Maary Callahan
Assett Managemen
nt, reflected on the finan
ncial crisis and
a
its effecct on her thinking aboutt risk
manaagement:
ppened in 20008 that no one ever co
ontemplated. The crisis catapulted
c
riisk
Things hap
maanagers to a seat
s
at the maanagement taable. They neeed to be askin
ng the ?what ifs?, to push, to
iteerate through various scenaarios, to help us think thro
ough how to manage
m
the business
b
betterr.
gement could
d very much be driven by
b an old-fasshioned, back
kward lookin
ng,
Risk manag
ch
heck the box mentality.
m
It keeps
k
us safee by making sure we prop
perly do the things
t
we haave
alw
ways done. But,
B
the probllem is not thee known risk
ks, it is the un
nknown riskss. And for th
his
yo
ou also need highly
h
sophissticated, highly savvy people who havee market skills and who can
thiink about thee ?what ifs.?
J.P. Morgan
M
Prrivate Ban
nk
Mo
organ?s Priva
ate Bank wass among the handful of the
t
most succcessful globaal private ban
nking
busin
nesses and wa
as known for its
i award-win
nning service and innovatiion.
Att its core, the business of private
p
bankin
ng was to pro
ovide ?high-to
ouch,? highly
y tailored pro
oducts
and seervices to weealthy individ
duals and fam
milies. The foccus of Morgan
n?s private wealth
w
manageement
effort was on capittal preservatio
on, capital grrowth, liquidiity, and the ch
hallenges of transferring
t
w
wealth
s
and products,
p
inccluding investtment
acrosss generationss. It offered a comprehenssive suite of services
advice, investmentt managemen
nt and brokerrage across a range of glob
bal products and markets. The
p
estaate planning and
a related advice,
a
often acting
a
as execcutors and tru
ustees
Privatte Bank also provided
of its clients? estattes, and offerred services to assist clien
nts in their philanthropic
p
c efforts, inclu
uding
hen appropriiate, the Privaate Bank also made
m
loans to
o clients. Morrgan?s
manaaging associatted funds. Wh
privatte bankers sa
aw themselvees as problem
m solvers, ofteen of complex
x cross-border problems, where
w
discreetion and inn
novation weree crucial for success.
s
At the
t end of 20007, the Privaate Bank geneerated
$3.7 billion
b
in reveenue, up $1.66 billion from
m $2.1 billion at year end 2004 (see Exhibit 1 for Private
Bank Revenues an
nd Assets Under Managem
ment (AUM), 2004-2009). AUM
A
were $260
$
billion att year
y
end 20044.
end 2007, up $68 billion from $1192 billion at year
______________________
__________________________________________________________________________________________________
Professo
ors Anette Mikes and
a Clayton S. Rosee and Senior Reserracher Aldo Sesia Jr.
J of the Global Reesearch Group prep
pared this case. HB
BS cases
are deveeloped solely as thee basis for class disscussion. Cases are not intended to serrve as endorsemen
nts, sources of prim
mary data, or illustraations of
effectivee or ineffective man
nagement.
Copyrig
ght ? 2010 Presiden
nt and Fellows of Harvard
H
College. To
T order copies or request permission
n to reproduce matterials, call 1-800-545-7685,
write Haarvard Business Scchool Publishing, Bo
oston, MA 02163, or
o go to www.hbsp
p.harvard.edu/educators. This publicaation may not be digitized,
photoco
opied, or otherwise reproduced, posteed, or transmitted, without
w
the permisssion of Harvard Bu
usiness School.
311-003
J.P. Morgan Private Bank: Risk Management during the Financial Crisis 2008-2009
Morgan competed with a number of different private banking models. These included businesses,
like Morgan?s, that were embedded in larger banks: HSBC, UBS, and Credit Suisse were formidable
competitors. Many securities firms also had units that catered to the very wealthy, including
Goldman Sachs and Morgan Stanley. And there were also independent firms, like Bessemer Trust,
Northern Trust, Pictet & Cie in Switzerland, and a multitude of small private firms. Each of these
had somewhat different models, from those that offered only a single service like investment
management or estate planning, to some that serviced the full range of client needs.
Erdoes, who was named as head of the Private Bank in 2005, reported to James Staley who ran
Asset Management?one of the largest money managers in the world, with nearly $1.6 trillion of
AUM at year end 2007.a It contained the Private Bank, an institutional investment management
business and a mutual fund business.
Erdoes, born and raised in Chicago, had a BA in mathematics from Georgetown University and an
MBA from Harvard Business School. After early experience in investment banking and investment
management, she joined Morgan in 1996 to work in the Private Bank as a fixed income asset manager.
The Private Bank served two client segments: its traditional ?ultra-high net worth? client base
(generally described as those with a net worth in excess of $25 million) and ?high net worth? clients
(those with a net worth between $5 million and $25 million). There were a small number of ?ultra
high net worth? individuals and families globally. For example, in the U.S. there were approximately
49,000 individuals with a net worth over $20 million in 2004 (see Exhibit 2 for U.S. wealth pyramid).
These clients ranged from heirs of long standing fortunes to technology entrepreneurs to hedge fund
managers, located across the globe. They had diverse and complex financial needs and lifestyles, with
markedly different tolerances for risk, and they could be quite demanding of their bankers. Erdoes
explained: ?Managing money is (just) one piece of our work. To do our job right we need to
understand as much about a client?s business and their personal needs as we can. We work
collaboratively.?
Consistent with the ?high touch? nature of the business, there was a high ratio of private bankers
to clients. The Private Bank employed over 7,500 individuals, of which nearly 2,000 were focused on
creating and managing investment products and client relationship management. It had 118 offices
globally. Erdoes believed Morgan had a unique advantage in serving its clients stemming from the
bank?s intimate client relationships. Bankers were able to collect and discretely share insights within
this substantial network of well-informed and very wealthy individuals.
With the 2004 Bank One merger, Morgan actively began to develop the capability to serve ?high
net worth? clients. There were significantly more potential clients in this group than in the ultra-high
net worth group, over 300,000 in the U.S. alone. While the needs of this group were similar in many
ways to those traditionally served by Morgan, the same highly tailored relationship-intensive service
and product set was not designed to meet the needs of this larger segment. There was a need for
products, services and a relationship management model that satisfied client needs, but that could
also be ?scaled? to deliver a consistent client experience.
Investment Model
The Private Bank had a differentiated model for providing its clients with discretionary
investment management services. Most firms operated either an ?open architecture? or a ?closed
architecture? investment platform. With an ?open? architecture, the firm did not have its own
investment capability and products, but evaluated those available from a variety of external sources
a In October 2009 Erdoes was promoted to head Asset Management, reporting to the firm?s CEO, Jamie Dimon.
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J.P. Morgan Private Bank: Risk Management during the Financial Crisis 2008-2009
311-003
and chose the ones that were best suited to client needs. The ?closed? architecture model was one
where clients came to the firm specifically because of its investment capabilities and style(s); these
firms did not offer externally managed investment products.
Morgan?s Private Bank had developed what was internally termed a ?managed architecture?
model, where it offered both Morgan Funds and externally managed fund products. The notion
behind this strategy was that clients who had access to Morgan?s extensive and widely recognized
global investment expertise might be, in some circumstances, better served by external products. The
internally available products could come from dedicated investment teams in the Private Bank or
from the institutional or mutual fund areas of Asset Management. This strategy required that the
Private Bank perform substantial due diligence not only on the external products that it offered to
clients, but also on those that were internally generated. (See Exhibit 3 for J.P. Morgan General
Investment Principles Regarding the Use of JPMorgan Funds and External Managers.)
A Morgan relationship banker had the job of considering all the needs of the client and what the
firm might offer to help satisfy those needs. These individuals often partnered with Private Bank
investment specialists, who would work directly with clients to advise on investment strategy and
products. In many cases, the Private Bank managed a client?s assets on a discretionary basis?that is,
the firm had full authority to make the investment decisions within a well-defined mandate. Those
involved in managing client money worked with a broad set of approved products. They used the
insights of a strategy team led by the Private Bank CIO, Michael Cembalest, to consider the Private
Bank?s views about opportunities and risks in the context of the specific needs and risk tolerance of a
given client.
Risk Management Challenges
The ?managed architecture? structure created some unique challenges. The discretionary
investment management platform in Morgan?s Private Bank was subject to fiduciary standards
governing self dealing and conflicts of interest. Notwithstanding the fact that the ?managed
architecture? model was intended to be Morgan?s way of delivering the best solution to a client, the
generic concern was to protect clients from having their funds directed to an internally managed
fund where a firm would likely make more money while there might be better external options
available.
The ?managed architecture? model placed a greater burden on Morgan to demonstrate it was
making the right decisions. To accomplish this, the Private Bank had a dedicated group that subjected
all internal and external investment products, strategies and vehicles to due diligence. Those that
passed this rigorous vetting process with high marks were added to the Private Bank?s investment
platform. The due diligence group?s reviews of investment products were ongoing and it had the
authority to remove a product from the platform at any time. In addition, the relationship bankers
and investment specialists performed annual reviews of each client?s account to make sure that the
products used in client portfolios were consistent with the goals agreed upon between the firm and
client.
Joseph Regan, head of Risk Management for Asset Management, reported jointly to Morgan?s
Chief Risk Officer, Barry Zubrow, and to Staley (and then Erdoes). Regan, who graduated from Saint
Joseph?s University in Philadelphia, had worked at Morgan for over 20 years. He started in risk
management functions and then spent time in Japan and Hong Kong before becoming the CFO of the
Asset Management business in the late 1990s. While on his second assignment in Asia, Staley asked
him to return to New York to take on the senior risk management role in Asset Management, which
he did in February of 2009 in the middle of the crisis. (See Exhibit 4 for the 2009 Organizational Chart
of Asset Management Risk Management.)
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J.P. Morgan Private Bank: Risk Management during the Financial Crisis 2008-2009
From an overall Asset Management perspective, Regan?s agenda focused on development of a
market-oriented risk function. He explained, ?We want a risk function that is capable of looking at
the details within our portfolios to understand more about the market-related risks.? Erdoes pointed
out that Asset Management more broadly, and the Private Bank specifically, had begun to evolve to
this model with the 2006 purchase of Highbridge Capital Management, a large hedge fund with a
?market-oriented risk manager? who was a partner with the traders. Regan added:
Within Asset Management, including the Private Bank, management of risk/return profiles
is primarily the responsibility of our portfolio managers. That?s thoroughly instilled in our
fiduciary culture as an investment management firm. I am aware of certain competitors who
have aggressive independent risk management protocols where risk managers are authorized
to ?sanitize? a portfolio, meaning they could hedge a trade or reduce risk tolerances if they
deemed it in the best interest of a client. We have a culture where the fiduciary obligation is
embedded and engrained in the portfolio managers, and we rely on that as our primary
protection.
But, we (Morgan?s independent risk management) want to enable independent insight on
the risks being assumed and raise the transparency and awareness of potential unintended
risks. Regardless of whether these risks reside within funds, or client accounts, or even across
our complex of investment strategies, we are seeking to be a second set of eyes partnering with
the portfolio managers.
With respect to the Private Bank, Regan initially identified three goals. The first was to strengthen,
where necessary, the traditional compliance-oriented monitoring that risk management had
performed. In addition to monitoring the issues around fiduciary duty for the ?managed
architecture? model, Regan?s focus included assuring compliance with investment mandates across
all investment teams and products. This included monitoring that clients were obtaining the
investment strategies they had agreed upon with the firm, which was often a product that
incorporated a broader set of portfolio decisions. Additionally, he focused on the governing processes
and support for the risk culture that were necessary to protect Morgan?s reputation through its own
actions, those of the firms it hired to provide investment products, and those of the clients that it
served. Finally, there was a need for ongoing review of the operational risks in the Private Bank; to
make sure that neither the clients nor the firm would suffer from breakdowns in documentation,
clearing, settlement or reporting.
To support the development of independent market-risk analysis, Regan sought to address the
need for a common language for risk within Asset Management. Portfolio managers within the
Private Bank (and across Asset Management more broadly) defined and analyzed risk differently as
was appropriate for their specific investment processes. Regan wanted a way to understand the
investment risk analytics at the institutional level supported by common risk language and
references. He said, ?We want to have a set of metrics that we can rely on to observe changes in risks
within investment portfolios. Regulators, clients and other interested parties, increasingly expect an
independent risk function to have this capability.? Regan also sought to create a mechanism (and
culture) for affording Morgan?s senior decision makers within the business timely access to
comprehensive information on investment risk. This would counter the tendency of larger firms to
compartmentalize information, thereby making it cumbersome to access at the moments when it was
most needed.
Erdoes summarized Regan?s essential roles as ?bridging? the two risk management cultures of
compliance/oversight and market risk awareness.
4
J.P. Morgan Private Bank: Risk Management during the Financial Crisis 2008-2009
311-003
The Global Access Portfolios
The first Global Access portfolio, established in 2005b, was among a select few funds that were
managed within the Private Bank. The portfolio?s original purpose was to provide a handful of Latin
American clients with the ?real time? benefits of the Private Bank?s best investment ideas. Initially,
the firm pooled money from these clients and created a fund that it managed on a discretionary basis.
It was soon available to other Morgan clients, including those characterized as ?high net worth.? By
year end 2007, there were $3.5 billion AUM in Global Access. The team consisted of 15 professionalsc
in New York, London and Hong Kong.
Chief Investment Officer Richard Madigan ran Global Access from its inception. Upon receiving
his MBA from New York University in 1990, he worked in investment banking and focused on
emerging markets fixed income, currency and commodities, spending several years in Mexico and
then New York. In 1998, he left emerging markets to become a money manager. In 2004, he became
the strategist for Morgan?s Private Bank in Latin America and a senior member of the Private Bank?s
investment team.
Madigan described the Global Access portfolios as ?dynamic, multi-asset class portfolios.? There
were four key investment strategies within Global Access that were built based on those used by the
Private Bank?s investment strategy team: Balanced, Growth, Wealth Preservation and Hedge Fundonly. The strategies were constrained by broad mandates that defined the proportion of assets
allocated across the main asset classes. For example, the Balanced strategy should have 40% invested
in equities, 40% in fixed income and debt, and 20% in alternative investments; however, tactical
portfolio asset allocations could deviate from these levels by up to 15%. Within these categories, the
Global Access team had the freedom to choose the investments they believed offered the best risk-toreturn characteristics for a particular set of clients. Unlike many investment products, the Global
Access portfolios were not designed to beat market indices or benchmarks. They were designed to
offer investors superior risk-to-return performance through the investment cycle. Georgiy Zhikharev,
head of Global Access risk management, explained:
Our investment process is not benchmark oriented. Rather, it is built around optimizing
risk budget utilization, which we generally view as the percentage of world equity volatility. In
that line of thinking, the ?up/down capture ratios? are linked to the equity markets. For
example, Balanced portfolios are expected to capture 60% of the MSCI World upside, but only
50% of the downside, provided that we are at 100% utilization of the risk budget. This sort of
differential in ?captures? should deliver 55%-60% of equity volatility while capturing 80%-100%
of equity returns over the cycle, and is likely to outperform equities in most cycles. Similarly,
for Growth portfolios we have 75% up/65% down capture targets; and finally, Wealth
Preservation is more like 35% up/25% down. The exception is the Hedge Fund-only strategy,
which is measured against a benchmark: HFRI Fund of Funds: Diversified index. While absolute
levels of capture may differ at various points in the cycle, and will depend upon the level of
risk budget utilization we are running, one thing should be constant: capture of return must be
better than the capture of volatility. The more we can achieve this, the more value we can
deliver from a risk-adjusted perspective.
There were five teams in Global Access, each overseen by a portfolio manager who reported to
Madigan and each was responsible for investment results. The teams were built around specific client
needs, based largely on geography and client segments: Onshore U.S., Onshore Europe, Offshore,
b Established as a Cayman segregated portfolio company and privately offered to select clients.
c 30 by 2010.
5
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J.P. Morgan Private Bank: Risk Management during the Financial Crisis 2008-2009
Alternative Asset only and U.S. Mutual Funds. By September of 2010, these five teams managed 23
separate portfolios, each based on one of the four investment strategies and designed to satisfy the
particular needs of a certain set of clients.
Madigan and his five portfolio managers, supported by Zhikharev, made all key investment
decisions for all Global Access portfolios, with Madigan having the final vote. These decisions
included asset class underweights and overweights, passive and active risk budget allocations,
manager selection and tactical rotations. Each portfolio manager was then responsible for translating
those decisions into the investments most appropriate for the strategies in his/her team. Selection of
implementation vehicles, timing of the rotations and cash management were among the portfoliospecific decisions they made.
Risk Management in Global Access
Madigan required each of the Global Access portfolio managers to have a view about the trading
and risk environment. He emphasized:
I am unapologetic as a boss and a colleague when someone does not have a view. You can
change your view every minute, based on information. What you cannot do is say to me, ?this
thing has just happened, what does it mean?? Everybody has to have a view the minute they
walk in the door.
He wrote Market Thoughts, a quarterly newsletter to investors, in which he underlined the
importance of view formation:
There is a degree of humility and staying power that should come with managing money;
you need to know what you can?t know. Markets by definition are uncertain; however, that
does not preclude having a view. The view is essential. So where do we think we are heading?
Madigan expected not only portfolio managers, but also risk managers to have a view too. In
Global Access, he wanted risk managers to serve as strategic partners.
Global Access? risk oversight operated in two teams. The first was the independent oversight
function run by George Lencyk, who was responsible for risk management oversight across all the
investment activities in the Private Bank; he reported to Regan. When Global Access started out, the
independent risk team worked on the initial new product approval and drafted limits for the
portfolio managers. Subsequently, the team monitored trade approvals, product suitability, and
investment performance. It also ensured that the governance processes were sound and compliant
with regulatory standards.
The second team, a new development within the Private Bank, was a precursor to Regan?s broader
goal of evolving the investment risk management function throughout Asset Management: this
positioned risk management as a ?business partner.? From the business risk management team,
Madigan recruited a market-oriented risk professional, Zhikharev, to become a risk advisor to his
team of portfolio managers. Zhikharev, born in Kazan, Russia, was educated at Kazan State
University and earned an MBA in Finance from DePaul University in Chicago. He had had nine
years experience in market risk management when he joined Morgan in 2001. Madigan explained the
rationale behind Zhikharev?s appointment:
I looked really hard for a risk manager. Georgiy was the one. When we were undergoing a
new product approval internally, he was the one guy in the room who was giving me a hard
time, the whole time. ?Can you explain that chart? I really don?t understand this one.? By the
time we walked out, I said we?re going to hire him. He has a passion for markets. What also
6
J.P. Morgan Private Bank: Risk Management during the Financial Crisis 2008-2009
311-003
won me over was that early in his career (1998), Georgiy worked in Moscow with an asset
management company while Russian markets exploded around him. That experience is hugely
important.
Since 2007, Zhikharev and his team of three have worked closely with Madigan and the Global
Access portfolio managers to help them think more deeply about the risks across positions, with the
goal of improving overall returns and protecting the portfolios from major downside shocks.
Zhikharev explained his role:
Allowing any team to run $9 billiond requires a lot of trust. My colleagues in independent
risk management who sit outside the Global Access team don?t necessarily have the proximity
and real time visibility of what trades and risks are being taken. So we want somebody on the
inside looking out for everybody?s interest, and that person is me.
I am not managing portfolios. I serve as a close business partner to portfolio managers. I?m
the team member responsible for keeping portfolios in alignment with both broad Private
Bank-level policies, such as Investment Review Committee process, fund concentration limits,
counterparty exposure limits, bite sizes, etc., as well as Global Access-specific, market-risk
related items such as trade approvals, portfolio risk analysis, positional concentrations, etc.
Market risk is my primary responsibility, but I also liaise with the independent risk team on
Private Bank policies. On one hand, I am there to make sure we are okay w...
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