Investing means making choices about how, when and where a company’s assets can be utilised to maximise returns. Safeguarding these assets is imperative, as any investment is subject to a range of risk including negative returns, earning below expectations, unfavourable market conditions or other conditions that may force the disposal of the assets at a loss. An organisation’s investments may vary but they all have to be managed in alignment with the company’s objectives. This may give rise to sometimes unanticipated complexities as different types of investment carry different risks at varying levels.
No reward without risk
Generally, the higher the risk a firm takes, the higher the reward it can hope to gain, but investments don’t usually have a guaranteed rate of return. Investments are inevitably vulnerable to market risk; losses may occur when share prices fall (equity risk) or when external investments become exposed to unfavourable foreign exchange rates (currency risk). The organisation may also be a victim of events beyond its control, such as political unrest which affects the value of its investment. This may affect its ability to maintain its investment and suffer a loss instead. But taking risk is an integral part of the business, and firms should be aware of potential pitfalls before putting down their money.
When a firm makes the effort to understand the risks that confront its investments, and applies the appropriate measures to manage these risks, it is demonstrating accountability to its shareholders and the ability to better position itself to attain its objectives. The investment path is fraught with danger, but if companies choose to take less risk, they could suffer the loss of lucrative opportunities and returns – making investment risk management a delicate balancing act. What companies need to have in place when it comes to investments, is clearly articulated processes and procedures that assess/evaluate investment performance that will support decisions which the firm will need to make.
Clarity needed from the outset
This starts with developing a clear investment policy statement that sets out the objective and strategy of the intended investment(s), and allocates appropriate assets as well as checks and balances, such as risk limits and constraints, proper benchmarking and performance measurement, as well as regular monitoring and reporting. In the course of developing its policy, the firm will naturally have to determine its investment appetite in tandem with the kind of investments it intends to make. Bonds, cash and cash equivalents are usually low-risk; options and futures are the opposite. How much risk the firm can handle will depend primarily on how much time, money and and other resources it has in relation to its investment sophistication.
But key to understanding the risks that confront investments, is recognising the need for a holistic approach to managing them, and making it a part of corporate strategy. While external risks such as the economic volatility of global markets, regulatory requirements of other jurisdictions and environmental conditions are beyond the organisation’s control, the company can ensure processes and procedures that lessen internal risks such as compliance with local requirements, data integrity and ethical behaviour. These cannot be unbundled from the prevailing organisational culture, and reflects the level of oversight and corporate governance practised by the firm.
Put the necessary systems in place
Effective investment risk management depends on organisational infrastructure, the firm’s human resources and its ability to set in place a workable framework. The right systems and processes will support its people in their management efforts while a framework will give the necessary direction to align investments with the organisation’s objectives. But what makes an effective framework which directs the operationalisation of the firm’s investing activities? And what can organisations do to protect themselves from the uncertainties of environments and markets, particularly in these disruptive times, when everything is in a state of flux?
Firstly, the organisation’s risk appetite and risk tolerance should be determined. This should include an assessment of how long and at what levels they may be sustained. The assessment will likely indicate where shortfalls lie, and help the organisation establish its tipping points and priorities, together with the benchmarks to use, and how to measure the performance of the firm’s investments. This process of data gathering and due diligence is an ongoing one; it starts when the organisation decides to initiate investment activity, and carries on from implementation to monitoring and review, to provide information for continuous improvement and refinement of the process.
What holds it all together
Developing the framework for managing investment risk, its procedures and processes, may underpin an organisation’s investment activity but these systems are only as efficient and effective as the people who manage them. Organisations may choose to invest in cash, bonds, property, shares, commodities, cryptocurrencies or start-up companies. All these have varying degrees of risk. Regardless of where an organisation decides to invest its funds, market analysts usually advise investing diversely, consistently and over the long term. Ideally, investments should be spread over different kinds of assets, different industries and a variety of investment products to reduce risk.
Investment risk can never be eliminated but diversifying investments means better chances of balancing them out if some sectors perform well and others don’t. Investing over the long term allows the investments to strengthen; there will thus be more time to recover from market fluctuations and inflation. Approaches to managing investment risk will vary according to organisational needs; there is no one-size-fits-all solution. But there are a few rules of thumb that should be considered, such as identifying risks early, communicating them succinctly, and prioritising them according to the firm’s investment objectives.
Risk management should be a part of the firm’s investment management programme from the outset; risks should be registered, tracked and updated. Uncertainty of markets and environments is a given, but this can be mitigated to some extent by identifying threats and opportunities early on, and thinking measures through. Tools that help manage a company’s investments risks are available, but ultimately, the organisation needs to decide what it wants, and how this should be managed, before being able to apply them effectively.
