(Answered)-Read the case "J.P. Morgan Private Bank". Answer the following

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

its effecct on her thinking aboutt risk

manaagement:

ppened in 20008 that no one ever co

ontemplated. The crisis catapulted

riisk

Things hap

maanagers to a seat

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

the business

betterr.

gement could

d very much be driven by

b an old-fasshioned, back

kward lookin

ng,

Risk manag

heck the box mentality.

It keeps

us safee by making sure we prop

perly do the things

we haave

alw

ways done. But,

the probllem is not thee known risk

ks, it is the un

nknown riskss. And for th

his

ou also need highly

sophissticated, highly savvy people who havee market skills and who can

thiink about thee ?what ifs.?

J.P. Morgan

Prrivate Ban

organ?s Priva

ate Bank wass among the handful of the

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

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

manageement

effort was on capittal preservatio

on, capital grrowth, liquidiity, and the ch

hallenges of transferring

wealth

and products,

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

estaate planning and

a related advice,

often acting

as execcutors and tru

ustees

Privatte Bank also provided

of its clients? estattes, and offerred services to assist clien

nts in their philanthropic

c efforts, inclu

uding

hen appropriiate, the Privaate Bank also made

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

discreetion and inn

novation weree crucial for success.

At the

t end of 20007, the Privaate Bank geneerated

$3.7 billion

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

were $260

billion att year

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

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

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.

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.)

311-003

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.

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.

311-003

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

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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