RiskGrades Technical Document

Feb 1, 2000

In 1994 J.P. Morgan, the global investment bank, launched RiskMetrics(tm), a transparent approach to measuring the risk of financial assets. RiskMetrics educated the world on the importance of understanding financial risk, and provided a data set to give institutions the ability to calculate their own risk exposures, as well as a technical document explaining all the mathematics behind the methodology. RiskMetrics was fully transparent and open, and free to all market participants and observers.

RiskMetrics quickly became the standard for institutions around the world to measure and manage their financial risks. Shortly after the launch of RiskMetrics, the regulators from the G-7 countries adopted a requirement that all banks report their market risk exposure. Over the last few years similar requirements have been extended to non-G-7-country banks, as well as non-financial institutions. Value-at-Risk, or VaR, the approach RiskMetrics made public, has now become the standard risk measure for over 5,000 institutions around the world.

The success of RiskMetrics was obvious. It filled a market need. Global markets were becoming more volatile and interrelated, more complex instruments such as derivatives were being traded, and firms were deriving an increasing amount of their profits from trading and investments in financial assets. Institutions were able to quantify the returns of these activities, but few were able to accurately measure their risks. They knew that some investments were riskier than others, but they didn't know by how much, or how to quantify the total risk of their portfolios of investments.

RiskMetrics was successful because senior managers, regulators, and shareholders recognized that Return Is Only Half the Equation. No decision should be made without understanding both the risk and the expected return of the outcome. RiskMetrics gave managers for the first time a transparent and consistent approach to quantify the risk of each of their financial investments and compare it to their expected returns, so that they could make better and more informed investment decisions.

Today there is a similar market need. Individuals around the world are taking on more responsibility for their financial futures. Investors as well as their financial advisors are looking at increasingly volatile markets and a wider array of increasingly complex investment options. And an individual's financial investments are more important to his future life than ever before. While individuals are given detailed return information, the best risk information they can get is "this stock or portfolio is aggressive," which they understand is riskier than "this stock or portfolio is moderate or conservative." They know that stocks are riskier than bonds, which are riskier than cash, but they don't know by how much, or how to quantify the total risk of their entire portfolio of investments.

To meet this need, the group that was responsible for RiskMetrics at J.P. Morgan is launching RiskGrades. RiskGrades is an open and transparent benchmark for individuals and their financial advisors to measure financial risk. RiskGrades include several components. First there is an online course, Understanding Risk, explaining the basic concepts of financial risk. Second, there is the RiskGrade TM data set allowing individuals the ability to measure the risk of stocks, bonds, funds, and other financial assets around the world. Third, there are the RiskGrades online analytics giving individuals the tools necessary to manage the risk of their own investment portfolios. Finally there are two documents -- Return is Only Half the Equation(tm) , a practical risk management guide for individual investors, and the RiskGrades(r) Technical Document, fully exposing all the calculations behind the RiskGrades approach. And all of the RiskGrades components are based on the same RiskMetrics research and technology used by thousands of leading institutions and regulators around the world.

The intent of RiskGrades is to help individuals make better investment decisions. RiskGrades do not by themselves provide advice, or make buy and sell recommendations. RiskGrades do not tell you what stock will do better in any one year, or tell you what investment strategy is right for you. Instead RiskGrades provide information about risk -- information that should be considered, along with the return information you are already getting, to determine the best investments for you and your portfolio.

We have all grown accustomed to the infamous phrase "historical performance is no guarantee of future results," and can be sure that no mathematical model can predict the future. Ultimately, successful investing can only be achieved by people -- people who have good information, good discipline, and good judgment. RiskGrades provide some of that information, and some of that discipline. The judgment is up to you, and when appropriate, your professional financial advisor.

Ethan Berman
CEO
RiskMetrics