Our son Patrick loves to explore, which as his parents, can make our hearts beat faster. Here he is climbing up on the window ledge in order to play with the door handle. He is taking a risk but he is also loving life. What should our response as parents be? Should we get rid of the risk by placing him on the ground? Should we manage the risk by placing a cushion on the ground? Should we let him continue as is and let him learn from any accidents that might occur and bounce back stronger?
The Chinese word for Risk comprises of two pictures. The one picture represents “Danger” whilst the second denotes “Opportunity”. This sums it up perfectly in my mind. The same situation can be viewed by some as dangerous (Patrick could fall and break an arm) and by others as a great opportunity (Patrick is developing great balancing skills and might also see something outside that he has never seen before). Which view is right? It depends!
We all have different risk appetites. Some will live on the ledge whilst others will observe from the safety of the ground – that is perfectly fine. Something we can’t afford to be however is ignorant of risk. As financial professionals we are entrusted by society to help identify and manage risks, especially in financial markets. Have we done a great job in this regard?
After the global financial crisis of 2008, society looked to business professionals and wanted to know why this economic meltdown came as such a surprise. Too often emphasis during qualifying exams was placed on the mastering of technical content at the expense of more pervasive skills like risk management. That has changed in the CA(SA) qualification process as all students are assessed on Strategy, Risk Management and Governance – it forms 10-15% of the first board exam.
If you would like to learn more about this important area, click on the following resources:
- Warren Buffett talks about risk management in these two videos – the one is from Fox Business and speaks to the view that as CEO he is “Chief Risk Officer” (2 mins) The other video is Buffett in front of the investigators of the financial crisis (3 mins)
- CIMA has a great introduction to the topic. They also produce a fantastic monthly magazine, Financial Management, that in August has risk and opportunity as the cover story. CIMA were also very clever with the cover as you can see below:
- The World Economic Forum that takes place in Davos every year, produces a Global Risks Report. The report has been produced for the past 11 years and has a great overview of what world leaders have identified. Here is one of the many diagrams included in the report:
- Nassim Taleb is probably one of the best people to read in this area. He is controversial and his motto, taken directly from his website is, “If you see fraud and don’t shout fraud, you are a fraud”. He was first reported on in The New Yorker magazine by Malcolm Gladwell but has since then written 4 books that deal with uncertainty and risk. I really agree with his emphasis on “skin in the game” as the best means of risk management.
- 6 mistakes executives make in risk management is a great article from Harvard Business Review that gives you a list of mistakes that can be made in practice:
- We think we can manage risk by predicting extreme events
- We are convinced that studying the past will help us manage risk
- We don’t listen to advice about what we shouldn’t do
- We assume that risk can be measured by standard deviation
- We don’t appreciate that what’s mathematically equivalent isn’t psychologically so
- We are taught that efficiency and maximising shareholder value don’t tolerate redundancy
- The Institute of Risk Management in South Africa is the professional body that does a lot of work in this area – including organising board exams for those who want to qualify as risk managers. They also have a list of suggested reading of their website.
Do you have any questions about risk management? Any resources we should explore? Let us know in the comments!