What is Risk?

In order to highlight the importance of risk management, it is important to first understand what we mean by “risk.”  Risk can be defined broadly as the possibility of loss or injury. In financial markets however, risk is typically more focused around investment risk – the probability that an investment’s realized outcome will differ from the outcome that is initially expected. This definition captures the main premise of risk, which is that when an investment is made, there is a chance that we may lose some or all of the investment depending on how risky that investment is.

Investment risk can be defined in several ways:

• The risk that an investment strategy or portfolio may underperform or gain
• The volatility of returns for an investment or portfolio relative to the broad market’s overall volatility.
• The volatility of returns for an investment or portfolio relative to its mean return over a specific time period.
• A measure of return as a unit of risk for an investment or portfolio over a specific time period to capture the return relative to the associated risk taken on to achieve the return.
• While these are risks that strictly relate to financial performance and investing, there are other risks that are faced by financial services firms such as banks, insurance companies, and asset managers.
• Market Risk: the risk that losses may occur to financial assets based on the dynamics of the overall financial markets, for example an equity security losing a substantial portion of its value.
• Credit Risk: the risk that a counterparty may default on their contractual obligations, for example an individual defaulting on their personal loan.
• Liquidity Risk: the risk that funding obligations may not be met due to cash constraints, for example a bank not having enough cash on hand to meet deposit withdrawal demand.

What is Risk Management?

Risk management is the process of identifying, quantifying, and managing or mitigating potential risks faced.

Risk management is undertaken by all players within the financial services ecosystem, including investment managers, investment banks, retail banks, insurance companies, among others. These types of companies all have distinct financial exposures, regulations, and internal risks which they face.

Risk managers must quantify and analyse the potential for losses, and either accept, mitigate, or transfer the risk based on a decision process that they deem appropriate.

The Importance of Risk Management in an Investing Context

In the context of investing, there is a lot of the focus on generating returns. This is logical since the entire point of investing is to generate some sort of return on an initial investment. Asset managers, for example, commonly compete based on their ability to produce returns, and usually attempt to outperform a benchmark index. However, there is often much less focus on the risk that is taken on to achieve that return.

The relationship between risk and return is a fundamental principle of investing that is oftentimes overlooked, especially by retail investors. Many retail investors feel that if they have achieved a greater return than the benchmark, then they have created value.

The reality of the matter is that you cannot un-marry return from risk. A return should always be framed in the context of the risk that was taken on to achieve that return.

Let us imagine an investor who achieved a return that was twice the return of the benchmark but took ten times the risk to achieve that return. Would you consider this return attractive? On a risk-adjusted basis, it clearly is not. Conversely, imagine an investor who achieved a return that was half of the benchmark but took on no risk to achieve this return.  That return is more attractive than it may appear at first glance.

Why become a risk manager?

As with almost every career, one of the motivating factors is the total compensation, especially at a senior level. Aside from compensation, there are some other factors that might motivate you to choose a career in risk management, including:

• Risk managers can work with a wide range of companies.
• Exit opportunities such as into private consulting roles are often possible.
• Risk management offers a high degree of job security.
• This field often appeals to those who enjoy solving problems, putting their quantitative and analytical skills to the test.
• Good work life balance for a career in finance, with decent compensation to match.
• That said, risk management is certainly not for everyone. It’s not a client-facing role. Moreover, suitable candidates should possess good quantitative skills and are able to deal with complex problems under pressure. Tight deadlines can be common and having a fair amount of regulatory experience is also helpful.
• Similar to other careers in finance, risk management can be very rewarding for those who enjoy a more analytical and quantitative role with less client-facing work in a dynamic sector, matched with decent compensation and work life balance.
• climb steps progress upwards
• Risk management hierarchy and progressing within the role

What does a risk manager do?

While the answer will partly depend on the exact position as well as the needs of the organization, here’s a broad outline of a typical day in the life of a risk manager:

• Analyses market or industry news
• Stock market movements or changes in asset values
• Review and work on ongoing projects and/or risk analyses
• Meetings with other in-house divisions, such as accounting, operations or compliance.
• Preparing risk analyses and presentations to finance regulators
• Compile daily or weekly risk reports
• Meetings with superiors to touch base on the firm’s strategy and understand how that affects its risk management framework and controls
• Sometimes, a portion of a risk manager’s day may also be spent learning new skillsets via training, as this field is constantly evolving and certainly not dull!
• Mind map strategy planning brainstorm thinking

How might someone become involved with risk management?

Similar to other roles within the finance sector, most candidates will first need to obtain a bachelor’s degree in a related field such a finance, business management or accounting. Completing a summer internship in risk department is useful means of gaining relevant experience and securing a full time role, especially at larger investment banks.

Risk management career path ladder

Risk analyst

One interesting point to highlight before moving on involves the fact that career levels tend to be stressed more than specific roles or titles.

An entry-level support position is normally associated with basic responsibilities such as assisting superiors, researching potential opportunities and learning company-specific risk mitigation procedures.

Titles can include “analyst”, “officer” or “assistant”. The time spent within this position will depend upon several factors including how quickly the candidate is able to grasp new concepts and what types of contributions he or she makes to the firm. This is also relevant for the other levels to follow.

Risk manager

Although this is sometimes considered to represent a managerial level, senior analysts will still need to consult with their superiors.

Some core duties associated with this position include liaising with other risk management specialists, developing in-house mitigation policies, communicating these policies with upper management, and overseeing how such changes are implemented within a practical environment. This position is also heavily focused upon identifying any potential risks to an organization.

Senior risk manager

This next career step will require a working knowledge of all compliance and regulatory issues, as these must be taken into account when creating an overall risk management strategy.

At this level, decisions may impact the entire firm. This is why other factors such as determining the “risk appetite” of the company and clearly communicating with stakeholders is crucial.

Furthermore, senior managers may be required to perform regular audits in order to determine if the firm’s finances are in order. There can likewise be times when senior analysts provide training and support to junior staff members.

Chief risk officer (CRO)

Other titles for this position may include director of risk management, managing partner or senior partner. Those who attain the title of a Chief Risk Officer (or equivalent) are generally considered to represent the top of the career ladder in risk management.

As a result, they are responsible for a host of critical duties. These can involve creating a top-down organizational risk management framework, implementing insurance policies, reviewing reports, and ultimately deciding whether or not a specific strategy is in accordance with the goals of the firm. Most individuals will remain in this position for the duration of their careers.

What to Expect from a Career in Risk Management?

A career in risk management can allow a professional to have a significant impact on their organization. The risk management field is fast-growing, and the work offers a range of benefits.

• Variety of Industries will offer prospective employment
• Making an Impact for yourself, employer & the society
• Career Path Satisfaction
• Compensation High

Importance of Risk Management for Finance Domain Specializations

1. Protect yourself from expensive litigation related to data breaches If your company is found negligent in a data or security breach, it could cost you significantly in litigation fees. …
2. Avoid costly fines for not complying with regulations …
3. Create a culture of risk preparedness so there’s less room for error
4. Risk management is important within the field of finance as the technology surrounding the field evolves, the tools used to manage risk must evolve as well.
5. Risk can be defined in many ways, including the risks associated with a particular investment or more broadly as the universe of risks faced by a financial services company (both internal and external).
6. Managing risk is important to avoid situations such as the 2008 Global Financial Crisis. Risk management is important to support a well-functioning economy and financial system.