By Allen He

Oversight boards and their investment teams often speak different languages when it comes to risk. The often repeated pattern is one of in depth discussions without clarifying long-term implications – not seeing the forest through the trees. Then, inevitably, board members are surprised by portfolio movements in the face of market stress events. Boards can take on a very short-term focus during such periods of uncertainty, often to the extent of losing confidence in the management team or their strategy and wanting to pull back on risk.

While no two organizations’ needs are the same, boards will want to be hands on with certain aspects of investment risk. Likewise, there are other aspects where the board would do best to take a step back and trust their risk team to lead. The guidelines below outline the different roles both parties play in maintaining the long-term strategy of the business.

Where to Start

There is no single set of default risk measurement tools and procedures. Strategy playbooks could be as varied as the organizations using them. Regardless of the size of the firm or which types of risk are being prioritized, it is the duty of the board to enforce the following standards:

• Frame trustees, executives, and risk teams in terms of organizational purpose and investment beliefs.
• Set expectations for the risk and return experience over time.
• Identify the performance thresholds and boundaries that matter for purpose – and any risk metrics that do not.
• Acknowledge organizational responsibilities, like climate commitments, that influence how you are able to take risk.

When to Lead

Management and risk teams look to the board to lead, especially in times of crisis. Boards that have a strong grasp of the scope of their organizations’ risk will be prepared to position the firm well in the near and long term. Accordingly, boards should assume responsibility in these areas:

• Inspire by explaining why risk decisions matter for fulfilling the organization’s purpose and related responsibilities, such as mitigating climate change, growing an economy, or promoting a more equal society.
• Oversee managerial preparations for handling eventual crises.
• Train with trustees, executives, and risk teams to maintain self-control during unusual or stressful market conditions.

When to Follow

While it is important for boards to understand the default assumptions behind the math and models, it can be easy to take risk metrics for granted without looking into the deeper nuances. Risk professionals are equipped to take the lead on changing existing defaults as long as boards remain open-minded and focused on the ultimate outcomes. Using a flight metaphor, boards should feel confident in empowering their risk team to set the organization’s “flight plan,” including:

• Measure volatility or other raw data inputs at a frequency that corresponds with the time horizon for performance.
• Prepare for scenarios of various liquidity need within this time horizon.
• Determine the likely range of performance during interim periods of the investment horizon.
• Anticipate crisis, including having a plan and signals of when to invoke it.
• Affirm the likelihood of performing purposefully over the organization’s time horizon.

Practice & Repeat

Consistent practice is required to stay up to date on risks, to know what questions to ask of the risk team, and to understand when and where things can go wrong. These guidelines are meant to complement – not replace – existing risk practices. Use this tool when onboarding new board members, establishing new risk functions, or adapting a current set of standards to be better suited to a long-term strategy.