Institutional fund managers can gain a competitive advantage by shifting their thinking to align risk with the long-term mission of their fund, according to Towers Watson.
In a report published today, entitled The wrong type of snow, the consultancy said that risk management had, until now, focused on harnessing technology for measuring risk rather than developing a deeper understanding of risk itself.
Tim Hodgson, head of the Thinking Ahead group at Towers Watson, urged fund managers to rethink this and promote better management ahead of risk measurement.
'We have come to a growing conviction that better risk management can give competitive advantage,' he said. 'Institutions can achieve this by shifting their thinking to align risk with mission by modifying practices to adopt a better risk framework and by bringing these together through stronger risk governance.'
Calling for risk to be redefined in the context of the fund's mission towards long-term value creation, Mr Hodgson said Towers Watson was increasingly defining risk as either 'impairment to mission' or 'surviving the whole journey'. It was also introducing the concept of adaptive buffers into its advice.
'These buffers are mechanisms, both financial and non-financial, that are available to the investor to support them through adverse periods and can be used with a consideration of different potential future scenarios to evaluate how much risk a fund should be taking,' he explained.
' We believe a risk "sweet spot" exists whereby enough risk is taken to generate wealth, given the available buffers, but not so much that mission is likely to be permanently impaired.'
Until now, risk models have over-emphasised short term success over long term goals and return ahead of risk, the report said. Models fail to deal properly with complexity and in particular endogenous risk -the risk that investors' own decisions and actions can alter the risk landscape.
Mr Hodgson said: 'Models have value, but only where they are employed with good understanding. By implication current practice needs significant enhancement.'
In the report, Towers Watson outlines how mission-related risk, adaptive buffers and risk measures can be implemented through a new risk framework. It also considers how asset owners can organise themselves to implement best practice in risk management.
'We argue that these frameworks require strong risk governance. As such organisations need to develop a risk culture where responsibility is shared appropriately and risk matters are given appropriate prominence on agendas and in communication,' Mr Hodgson said.