be_ixf;ym_201911 d_13; ct_300

Investment Management
Principle 5: Risk Management

May 3, 2016  | by Commonfund Institute

Governance and Policy | Industry Knowledge | Investment Strategy | Risk Management

Welcome back to our seven-part series where we highlight key issues and essential principles of investment management. Part IV reviewed Manager Selection – which provided some questions to consider during the selection process.  Now it’s time to discuss principle #5: Risk Management.

 

Essential Principle

Risk can be defined broadly as anything that can result in the objectives of the portfolio not being met. The process of risk management seeks to enable fiduciaries to make the best possible investment decisions in the face of uncertainty and to maximize the likelihood that your portfolio objectives will be achieved. This is accomplished by harnessing those risks for which the portfolio is being compensated while minimizing the occurrence and impact of non-compensated risks.

Compensated Risks

Investment risks are the most common of the compensated risks. This is when the investment return is expected to be positive in the later stages of its maturity but the productivity of returns in the short and medium term are less certain. When this happens, the portfolio may fail to reach the total return target at any point. It may also fail to have the sufficient liquid income or assets available to be transferred to beneficiaries or the operating budget if needed.

For this reason, your investment return target and funding targets should be rigorously defined and explicitly related to your ability to accept illiquidity and temporary mark-to-market losses. Your policy portfolio should specify these compensated investment risks and expected returns, both as targets and within reasonable ranges.

Non-Compensated Risks

Not all risks taken during the investment process are compensated for. Certain things like operational and counterparty credit risk failures can occur during any part of the investment process where assets move among managers, agents and intermediaries. Examples of non-compensated risks would be failures in the safekeeping and accounting of assets, a failure to comply with legal or regulatory obligations, failure of a derivative counterparty, or failure to avoid outright fraud. These risks should be avoided as much as possible, and mitigated when they cannot be avoided. Risk management here consists of due diligence to ensure that you are dealing with counterparties and managers of complete integrity and competence, ongoing monitoring of manager and counterparty quality, and diversifying or insuring against unpredictable events.

 

New Call-to-action

Subscribe to Insights Blog

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.

Disclaimer

Information, opinions, or commentary concerning the financial markets, economic conditions, or other topical subject matter are prepared, written, or created prior to printing and do not reflect current, up-to-date, market or economic conditions. Commonfund disclaims any responsibility to update such information, opinions, or commentary. To the extent views presented forecast market activity, they may be based on many factors in addition to those explicitly stated in this material. Forecasts of experts inevitably differ. Views attributed to third parties are presented to demonstrate the existence of points of view, not as a basis for recommendations or as investment advice. Managers who may or may not subscribe to the views expressed in this material make investment decisions for funds maintained by Commonfund or its affiliates. The views presented in this material may not be relied upon as an indication of trading intent on behalf of any Commonfund fund, or of any Commonfund manager. Market and investment views of third parties presented in this material do not necessarily reflect the views of Commonfund and Commonfund disclaims any responsibility to present its views on the subjects covered in statements by third parties. Statements concerning Commonfund’s views of possible future outcomes in any investment asset class or market, or of possible future economic developments, are not intended, and should not be construed, as forecasts or predictions of the future investment performance of any Commonfund fund. Such statements are also not intended as recommendations by any Commonfund entity or employee to the recipient of the presentation. It is Commonfund’s policy that investment recommendations to its clients must be based on the investment objectives and risk tolerances of each individual client. All market outlook and similar statements are based upon information reasonably available as of the date of this presentation (unless an earlier date is stated with regard to particular information), and reasonably believed to be accurate by Commonfund. Commonfund disclaims any responsibility to provide the recipient of this presentation with updated or corrected information. Past performance is not indicative of future results. For more information please refer to Important Disclosures.