Risk management technology: BlackRock’s Aladdin Risk

Market moves in the past year have been highly volatile across several asset classes. This has presented a challenge for central banks, particularly those that have diversified their foreign exchange investments into new assets such as credit instruments and equities. Being able to more accurately assess the real risks, returns and diversification trade-offs linked to portfolio positions against customised benchmarks using credible stress scenarios is crucial to ensuring investment positions are correctly balanced.

This is where Aladdin Risk, the risk management engine developed by $10 trillion asset management company BlackRock, offers an edge. The system not only provides daily transparency via portfolio positions and exposures, performance and attribution, portfolio risk, scenario analysis, compliance and oversight, but also helps institutions – of all types – rethink and redefine portfolio management. Whether its clients want to gain a better understanding of their underlying risks, asset allocations or green portfolio construction, the platform delivers an accurate feed for timely reporting of positions – both internally and externally managed – across most asset classes and instrument types, including derivatives, structured products and exchange-traded funds.

In the past year, the service has also included information on private assets, such as real estate, private equity and infrastructure. While most central banks are not active investors in private assets, many sovereign wealth funds are investing in such areas.

All of this is designed to give investors the data and transparency to make their own decisions across different metrics, including duration, convexity, value-at-risk, credit risk measures and credible stress tests. Central banks can choose the best individual or combination of metrics to suit each use case. For example, one institution has recently implemented VAR – which offers an alternative measurement to credit spreads – to determine expected credit loss by estimating probabilities of default, recovery rates, and provides a clear view via a rating transitions matrix.

Complex benchmark

Another benefit of the Aladdin system for reserve managers is the ability to create customised benchmarks – measured against performance. Aladdin not only allows customisation of the types of assets referenced, but also the currency benchmark – and BlackRock has specifically configured the platform to accommodate a central bank client, Bank of Israel.

The Israeli central bank – which started using Aladdin in 2019, and now manages $208 billion in FX assets (including reserves bought under its natural-gas purchase programme) – sets its currency benchmark, a basket of currencies that will be used, in addition to the shekel, for measuring the rate of return on its foreign exchange reserves. As the rate of return on the FX reserves is also measured in terms of the currency benchmark, its composition is defined as the risk-free currency composition for the reserve portfolio managers. It then ensures its asset exposures are aligned to the basket from an FX exposure perspective.

“They have a sophisticated, hybrid benchmark structure, which required some system customisation to ensure we could properly support it,” says Oded Levin, director in the Aladdin analytics and quantitative solutions team at BlackRock.

Another major gain for Bank of Israel from Aladdin was that it previously had no single and consistent view of risk and return across internally and externally managed assets. The introduction of Aladdin provided for this.

“A portion of our portfolio, which includes equities, corporate bonds and mortgage-backed securities, is externally managed across various external managers,” says Roee Levy, a senior analyst in the risk management unit of the markets department at Bank of Israel.

“In Aladdin, in addition to the positions of the internal portfolio, we can also see our holdings with each external manager on a daily basis, which allows us to analyse our internal and external investments in a more holistic way.”

Another important set of benefits for reserve managers are related to environmental, social and governance (ESG) considerations – as well as climate modelling tools linked to securities. Reviewing ESG factors is becoming an increasingly important task for central bankers investing taxpayers’ money. Aladdin’s platform capabilities allow reserve managers not only to analyse their positions from an ESG perspective, but also assess the ESG impact when making portfolio changes.

This ESG turnkey solution can also make it easier to provide ESG information externally, helping to meet evolving needs for transparency. “Central banks will likely have to provide greater transparency into how the portfolio is considered from an ESG standpoint,” says Yitzi Stern, a managing director at BlackRock Solutions.

Ultimately, Aladdin Risk is a vast risk technology engine that also offers stress-testing capabilities that provide useful insights into portfolio behaviour under macroeconomic circumstances or changes in market context, such as increased or decreased volatility. This ability to stress different scenarios, where covariance matrices or individual factors are shocked, can help reserve managers obtain clearer insights into portfolio impact, based on Aladdin and/or their own data.

This capability can be used as part of a regular asset-allocation process to analyse sensitivities of strategic portfolios within various scenarios and potential events – to better understand overall resilience.

The stress tests and scenario analysis can also be used to analyse the risk to the portfolio from new events that cause heightened volatility. It’s something the Bank of Israel is currently investigating in the context of the ongoing crisis between Russia and Ukraine.

“For this analysis, we used long-term correlations according to our standard long-term model that we use on a regular basis. In addition, we have examined the results of the various scenarios by using short-term correlations as well, based on the period of pressure around 2014 when Russia invaded Crimea,” Roee explains.

“Undoubtedly, using Aladdin has been a major step for improving and promoting our risk management,” says Bank of Israel’s Roee. “Even today, two years after the implementation of this tool, we still continue to learn how to better use it and utilise its capabilities for our risk management needs.”

The Central Banking Awards were written by Christopher Jeffery, Daniel Hinge, Dan Hardie, Victor Mendez-Barreira, Ben Margulies and Riley Steward