In 2002, Pictet Asset Management (PAM), the investment business of Pictet & Cie, one of the largest Swiss private banks, decided to create a separate risk function. Set up by Gianluca Oderda, head of risk control, it has demonstrably saved the business from investment losses while proving an attractive selling point to PAM's institutional investors, which provide the bulk of its SFr122bn (US$100bn) in assets.

"During the final selection process when we pitch for business, all the big institutional clients scrutinise the risk process," says Mr Oderda. "We have to present our infrastructure and explain how it all works."

Initially, the focus of the risk function was on investment performance, the heart of PAM's activities. Without strong performance and the ability to avoid portfolio losses, PAM would soon lose the trust of investors. The risk function was therefore set up to be entirely separate from the portfolio managers, reporting directly to the managing partner. Its four-strong team is dispersed among PAM's main investment centres in Geneva, London and Singapore.

However, Mr Oderda adds that if risk control is to work successfully, it is also important to earn the trust of the investment team. "The risk managers must not be seen as policemen or the enemy. [They] must work side by side with the investment teams and convince them that focusing on risk adds value, leads to better constructed portfolios and helps avoid errors."

The system PAM put in place allows the risk managers to view the whole book of business and to spot lapses in discipline. It can deconstruct the risks in many different ways, such as into equities, bonds, sectors, regions and credit ratings, so that exposures can be measured and controlled. This information is made available to all PAM's investment professionals via a proprietary application, called Profolio.

"All positions are sent to the risk server engine and it sends back information that the managers can act on," says Mr Oderda. The portfolios are screened daily and an automatic alarm is triggered if there is excessive exposure to any risk factor. The same is true of the individual portfolios. Many of them have target risk budgets, which refer to the amount that a manager is allowed to deviate from the benchmark, such as the S&P500. These budgets are agreed in advance with the investor and, if they are breached, the risk function would be alerted and the manager would have to explain the deviation.

"At the same time, we encourage managers to take risk," says Mr Oderda. "If they don't take risk, they can't generate alpha (out-performance)." In other words, the screening can also uncover portfolio managers who are too cautious and likely to underperform. Each investment unit is reviewed quarterly. Meetings take place in which the processes are set out before the chief investment officer, the managing partner and the risk control unit. The risk control unit also presents data on risk factor scenarios and stress-testing. "There are plenty of questions asked and nothing is left unsaid," explains Mr Oderda.

The thoroughness of the risk process has uncovered potentially disastrous problems in the past. For instance, it was realised that the stocks in the PAM emerging-market funds had on average too little liquidity to make a timely exit in the case of a sharp market downturn. "We decided to soft-close the funds so there would be no more inflows," says Mr Oderda. "This protected existing fundholders."

In 2005, PAM added an operational risk function that focuses on workflows and processes. It was charged with setting up a database containing the history of operational problems at PAM. This has helped reduce errors such as duplication of trades, a common mistake in the fund management industry. "We can also intervene in the weakest areas of the business, such as the processing of credit derivative trades," says Mr Oderda. Since the processing of such trades is not usually automated because of their complex nature, it is harder to aggregate the risks.

There could be too large an exposure to one counterparty or to the bonds of one particular company. "The limits are dictated by compliance," says Mr Oderda. "No more than 10% of the total capital of a fund can be traded with a single counterparty."

Indeed, the risk managers work handin- hand with the ten-strong compliance team. When PAM wins an investment mandate, the risk unit will, for instance, detail the tracking error risk in the contract, but the compliance team will make sure it is workable from a regulatory and legal standpoint. Crucially, the two functions are independent of each other and of the investment teams.