RISK
MANAGEMENT
Investing has many dimensions of risk. Managing these risks requires focusing on outcomes, understanding risk drivers, and critically, developing appropriate responses .
Risk is a process.
The 6A's of Risk
The essence of investing is risk management as it defines the risks to accept and the risks to avoid. Inherent in the investment decision is ensuring compensation for any risk taken. To paraphrase the Chinese character for risk: risk must present opportunity; otherwise, it is pure speculation. An institutional investor's core mission is to manage risk from the minutiae of the security to the scope of the investment program to ensure achievement of the strategic intent of the organization. Even when the journey takes a path different than the one expected, achieving the objective is still possible for the risk-focused investor. While success is not guaranteed, focusing on risk keeps the investor in the game.
We must live in the present in the face of an uncertain future. Even the best laid plans can go to the way side. To ensure that the strategic objectives in business and investing are achieved requires a robust risk management process to manage the uncertainty. The 6A's of Risk are:
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Assess: what is the risk context?
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Analyze: where is the risk?
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Alternatives: how is risk classified?
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Align: who manages the risk?
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Act: when to respond?
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Adapt: why did the risk occur?
While the future is littered with mines that will cause strategic drift and meteorites that will change the game, a robust risk management process will ensure that the business or the investor survive to see another day.
Managing Risk. All investors are pushed off course sometimes. Astute investors from Benjamin Graham to Warren Buffet extol the virtues of investing with a ‘margin of safety’ and ‘intrinsic value’ to ensure when they miss, they miss small. They ensure that the risks are well managed and then permit the returns to follow from the compounding of capital. An investment philosophy intertwined with this belief removes outcomes that results in strategic drift too far away from the objective while permitting participation in opportunities as they arrive.
Future returns in the financial markets are inherently an uncertain game that depends upon timing. Placing too much confidence on uncertain future performance outcomes puts the investor into a situation where time is an enemy rather than an ally. As all visitors to Las Vegas know, in the long run, only the house wins. Investment decisions start with evaluating investment strategies that provide sustainable cash flows independent of the environment. Returns should be as consistent as the house, not variable like the player. While there is no guarantee of success, an investment philosophy predicated on managing risk helps achieve more persistent investment performance.
Capitalize on Risk. There are many risk processes that provide insight. The 6A's of Risk seeks to achieve the same objective within a simpler framework because the greatest risk is the inability to manage risk. Getting lost in complex steps and analysis can take the business or investor away from the real objective: managing. Risk is inherently uncertainty about the future. The simple objective of the 6A's of Risk is to ensure a well articulated action when a risk occurs. The process starts with asking what is the risk context, where is the risk, and how is risk classified. Together these broadly for the the measurement dimension.
Armed with the knowledge of the risk context, where risk resides, and properly classified risk, the next critical dimension is managing risk. Managing risk is where the critical decisions of who makes the decisions, when to respond, and understanding why risk is occurring. Making the jump from measurement to management requires a risk focused culture to help ensure the best risks are taken. Business and investing success is predicated on accepting risk: the 6A's of Risk provide the framework for managing the process.