Risk culture versus opportunity culture: When things are looking up, it’s all about seizing opportunity. When things are on the downswing—like now—our attention turns to risk. That’s the way things go. But they shouldn’t. We should always develop and operate in a risk culture.
During the five years I was the chief risk officer for the University of California pension and endowment, the CIO Jagdeep Bachher and I embarked on a program of creating a risk culture. Risk management went hand-in-hand with looking for opportunities. Indeed, one of our annual reports could be opened two ways. The cover on one side of the annual report had “opportunity.” Turn the report around, and the cover on the other side had “risk” with the text going the other way.
A pension acts to meet the financial objectives of individuals—in the case of the University of California, over a quarter of a million individuals and a portfolio of over $150 billion—and the program we built there has lessons for the advisor working with individuals one on one. So, here is what I mean by risk culture, and ways to incorporate risk culture into portfolio design and investment decisions.
Risk Culture Is Human
Risk is not a number, it is a narrative, a story that weaves through the client’s portfolio and objectives. Quantitative measures are an end for those looking at the one dimension of returns, but an individual is multidimensional, with life objectives like building a solid based of financial security, maintain lifestyle into retirement, and perhaps reaching toward aspirational goals.
Risk Culture Has A Common Language
The foundation of a culture is a common language, a shared mode of communication. So as a starting point, risk culture means creating a common language for measuring and evaluating risk. The standard language for risk is risk factors. These thread through the various assets in the portfolio, represent risk in a concise and intuitive way; often a handful of risk factors can explain over 90% of a portfolio’s non-idiosyncratic risk, even if the portfolio contains hundreds of assets.
And the same language means sharing the same risk application and risk metrics from the CIO to the advisor to the client. And doing this even beyond the risk application; having the same data, and data tags and schema extend from the core performance reporting system to the applications that feed off of that data.
Speaking about risk in the same way means more than reciting the same numbers. It is sharing risk narratives, sharing the understanding of how risks might evolve and how they will percolate down to affect the client's portfolio and life decision. An example: I've worked as the chief risk officer as many institutions, and when there was a risk issue—and it did not have to be a crisis—I’d be sitting at a table with the CEO, CIO, and the heads of the trading areas. We would have risk reports as references, but our discussion amounted to telling stories, what-ifs on how things might evolve. One person might finish another's sentence, or embellish the story based on a different perspective the markets and experience.
Risk Culture Is Active
A culture is active. It requires taking action to be vital. Without action, it might be better defined as a risk ritual. When we designed or modified a portfolio, or consider a new investment, the risk issues are front and center. For portfolio design, this means looking at the portfolio in terms of its risk factor exposure to see the marginal effect of incremental changes, to see the exposure to sectors, countries, and investment styles. Risk factors are essential for this, because risk is not always obvious when looking asset by asset. Amazon is primarily in retail, but it has a loading to the technology risk factor because of its revenue from cloud services. Speaking of cloud services, take another example, Equinix. It is a real estate company in the specialized REITS sub-industry, but its main business is running data centers.
For private equity or real estate deals, it means seeing how they fit in to the total portfolio as opposed to their stand-alone risk and opportunity. For example, at UC we looked at buying an office building near the Stanford University campus, and considered how the rental income might be affected by a downturn in technology and how it might correlate with stresses on the university's tuition.
Risk Culture Is Dynamic
I think of risk in the context of culture because just as culture is the essence of our human condition, and risk is human as well. We learn from experience, we innovate and create. We change in our tastes, our life circumstances, and our focus on the various investment objectives. For example, the focus on security will be different for the client with a young family, struggling to build up savings than it will be once that client becomes an empty nester with substantial wealth. And this has to be at the center of how we look at risk, especially the risks that are material for the longer time frame of individuals.