Practical analysis for investment professionals
02 November 2012

Five Questions Every Investment Trustee Should Ask about Risk

Benjamin Graham, the father of security analysis, once said, “The essence of investment management entails the management of risk, not the management of returns.” This is advice that every investment trustee should take to heart.

Why? Because when fulfilling ones duty as a trustee, “risk plays a much more important role than do returns,” according to A Primer for Investment Trustees, published in 2011 by CFA Institute Research Foundation. “Returns are the past; risk is the future. The investment committee can attempt to influence the direction of the Fund only in the future, not in the past.”

The main types of investment risks are:

  • Capital market risk
  • Active management risk
  • Liquidity risk

But how does a trustee quantify risk?

“It doesn’t matter whether one uses a qualitative process, quantitative process, or a mix of the two,” the authors write. “What is crucial is that the process be structured, comprehensive, and proactive rather than ad hoc, narrow, and reactive.”

Risk means different things to different people, and we don’t all share the same appetite for risk — in other words, we all have different ways of handling the ups and downs of market and its effect on our investments.

“Perhaps the most important part of managing risk is the human element,” the authors add. “The markets are unpredictable in unpredictable ways. There will always be more unknowns and chaos to confound us.”

Understanding investment risk tolerance is important because expected returns are directly related to risk. “The higher the returns that the investment committee targets for the Fund, the more risk the fund will have to incur,” the authors say.

It is important for a trustee to understand the difference between his or her personal risk tolerance and the investment committee’s risk tolerance and to focus on what is best for a fund over the long run.

Here are some questions that every investment trustee should ask:

  • What risks do I face as a fiduciary?
  • What are the most important risks faced by the fund? Who is responsible for managing each of them? What are we doing (or not doing) to mitigate those risks?
  • Given the current investment policy, how much could the fund lose in a “worst-case” scenario?
  • What market events could cause serious liquidity concerns for the fund?
  • Is there general agreement among the trustees that the level of risk in the fund is consistent with the fund’s mission and investment objectives? Where has there been disagreement?

You can access more questions by clicking on the primer. It’s a go-to resource for information on governance structure, investment policy, the fund’s mission, investment objectives, risk tolerance, investment assets, performance evaluation, and ethics in investing. And if you would like to learn more, our e-learning session for investment trustees is a free online resource.


Please note that the content of this site should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute.

About the Author(s)
Lauren Foster

Lauren Foster was a content director on the professional learning team at CFA Institute and host of the Take 15 Podcast. She is the former managing editor of Enterprising Investor and co-lead of CFA Institute’s Women in Investment Management initiative. Lauren spent nearly a decade on staff at the Financial Times as a reporter and editor based in the New York bureau, followed by freelance writing for Barron’s and the FT. Lauren holds a BA in political science from the University of Cape Town, and an MS in journalism from Columbia University.

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