On 30 May, FCLTGlobal Members and guests met in Boston for a peer-to-peer discussion on managing risk to support long-term value creation. The Forum on Risk: A Balancing Act provided a venue for participants to exchange examples of multi-horizon risk management, including successes in practical applications and challenges with implementation.
To open the event, FCLTGlobal CEO Sarah Williamson emphasized the importance of handling near-term situations to preserving a fund’s ultimate long-term objective.
“Managing risk in a way that serves a long-term purpose means building a strategy that can get you there, anticipating the uncomfortable places that strategy may take you along the way, and planning for how you’ll handle those them when they arise,” said Williamson
With an eye towards participation and engagement, the forum included six sessions, summarized below, with attendees discussing the issues in smaller groups before sharing takeaways with the entire room.
Risk Oversight by Trustee Boards
The gathering also celebrated the contributions of prior working group participants to FCLTGlobal’s recently published report, Balancing Act: Managing Risk Across Multiple Time Horizons. A focal point of that report was strong communication on risk management between boards and staff. In the first session, participants shared their experiences in boards’ risk oversight sessions, including ways that they create a common information baseline, build appetites to take certain long-term risks, and anticipate board-level responses when risk materializes. Key takeaways included:
- Effective communication with the board isn’t just a matter of information-sharing. It’s about jointly anticipating and preparing for the risks and opportunities ahead.
- Small nudges can make a big difference, such as using charts, visually emphasizing key numbers or moving long-term information to the top of the board packet.
- The board has a responsibility to oversee the health of the entire organization. Staff also have a responsibility of bringing risk content to the board at a level that enables them to use it as part of their broad oversight, not focus solely on deep technical details.
- Board members and risk professionals alike are subject to human behaviors like cognitive overload, loss aversion, and hyperbolic discounting. The task is to anticipate and manage these behaviors, not to eliminate, shame, or ignore them.
- Long-term planning with the board should be somewhat binding, but not written in stone. When the world changes, sometimes plans need to change with it.
Risk Provisions in Owner-Manager Mandate Agreements
The morning session concluded with a focus on investment mandates' risk provisions, where participants considered provisions that could be included in mandate agreements to ensure that asset owners and managers communicate, measure, and anticipate risk in a long-term way. Key takeaways included:
- Integrating risk provisions into mandates creates a clear, grounded understanding of the owner’s risk appetite and the manager’s risk profile.
- A risk-informed mandate could also require disclosures with long-term import, introduce longevity discounts, or open space for new fee structures.
- Spelling out customized benchmarks can distract from the higher-level need to establish shared principles — while also making it harder for investors to adapt to new situations as the world evolves.
- Visual aids could be clarifying as well, possibly including social network graphs that show entangled risks along with scenario or shock analyses.
- Positioning portfolio managers to take charge of these contracts as an element of investment strategy instead of deferring the contracts to legal teams.
Hear from our Members about the importance of strategic risk practices and processes:
The lunch hour included an in-depth discussion with Sarah Williamson and MIT’s The Engine
, an enterprise designed to support new companies working on scientific and technological innovation. The pair discussed how investors can support technologies with limited short-term revenue potential but tremendous long-term disruptive power. Most venture capital arrangements envision a ramp-up window of about 5-7 years before payout, which is too short for some transformative efforts. Providing long-term capital, knowledge, network connections, and specialized equipment can help companies advance to the point where they may be attractive to VC investors or public markets. Long-term initiatives, like The Engine and others, may be a natural fit for investors with long-term liabilities, like pension funds.
Climate Change and Carbon Risk
The afternoon kicked off with a conversation on climate and carbon risk. Many of today’s long-term-oriented investors are pioneering ways to address this risk, from measurably reducing portfolios’ carbon footprint to allocating assets in a way that earns a long-term return while advancing climate-related Sustainable Development Goals. In this session, participants exchanged the latest information about their methods for and insights on managing climate risk, including:
- Clients and beneficiaries are increasingly demanding attention to climate risks
- Historically, climate change is unfolding on a time-scale even more elongated than most long-term investors generally consider.
- Measuring the precise economic impacts of climate change is challenging. Rather than fixating on measurement, investors may benefit more from thinking about this risk in terms of managing behavioral tendencies – like becoming comfortable with a departure from the status quo.
- Investors also have to consider likely regulatory changes around the world and how those might impact both the path of climate change and the response of global businesses.
- There are opportunities for investors, like technologies that contribute to a low-carbon economy, because not all climate risks are fully priced into the status-quo economy.
- Communicating climate-related investment decisions with beneficiaries is difficult because it involves probabilities across a wide range of possible outcomes.
- Divestment from companies exacerbating climate risk may not always be the best option, if long-term engagement can influence their behavior.
Taking Action: Application in FRM Certificate and GIPS Compliance
In a penultimate “lightning round”, a small panel of guests discussed the conclusions they’ve reached while refining traditional metrics to better suit long-term risk management:
- The balancing act of risk management is a matter of optimizing long-term returns while avoiding a set of unacceptable short-term risks along the way.
- Long-term risk is not necessarily just the sum of many short-term risks – the drivers of long-term risk are unique. Variations in historical performance over long periods are much bigger than people generally realize.
The final workshop of the day dealt with reputational risk. An asset owner’s responsibility for the reputation of the fund sponsor is vital and complex. Similarly, an asset manager’s reputation affects their ability to earn and maintain mandates from asset owners. In this session, participants explored the practical, long-term implications of reputational risk, including how to anticipate and communicate its impact. Key learnings included:
- Reputational risk may ultimately be the byproduct of some other breakdown.
- It’s often hard to foresee when (or why) your reputation will come under attack. What matters is the speed and directness of the response.
- Reputational risk seems to be everywhere in modern society, given the depth of social divisions and social-media-fueled opportunities for outrage. Yet in some ways the world seems to have gotten more forgiving, thanks to scandal saturation.
- Building up good standing provides a “halo” to partially insulate organizations from reputational risk.
- Minimizing reputational risk requires not just the right rules but strong norms of appropriate behavior.
- There are real costs associated with minimizing reputational risks, including increased internal management.
The Forum on Risk was designed to focus on practicality. As such, our discussions shed light on practical ways to manage multi-horizon risk with an eye towards long-term value. They key learnings revealed over the course of the day will both inform FCLTGlobal's research and shape our collective outlook on risk management moving forward. Thank you to Natixis Investment Managers for generously hosting the event, and to all of our speakers, presenters, and guests who made our agenda so engaging.
To learn more about our research on long-term portfolio risk, please refer to our recent work, Balancing Act: Managing Risk Across Multiple Time Horizons. For updates on new and upcoming work from FCLTGlobal, follow on social media @FCLTGlobal.