How best to manage risk in organisations

By Odhiambo Ochola

An integrated risk management strategy supports a broad view of financial statements.

Organisations should pursue a strategy that accounts for interrelationships among operations, investments, and financing. Companies operating results have become increasingly volatile in the current economic environment.

Financially, big organisations often have both large investment balances and large debt obligations on their balance sheets. The same is true with regard to some liabilities, which usually appear only in balance sheet footnotes.

Traditionally, companies have depended on specialised financial advisors to manage risks associated with operations, liabilities, financial investments and debt liabilities. Given the complexity of today’s environment, however, such an approach can expose organisations to unexpected and significantly unwelcome volatility in overall financial results.

Like it or not, there are direct and indirect relationships between an organisation’s operating assets, financial assets and liabilities, and pension fund assets and liabilities. To better prepare for volatility, organisations need to be aware of these relationships and incorporate them successfully into an integrated risk management approach.

RISK MANAGEMENT

Integrated risk management requires not only understanding the risks within the areas of operations, investment, and financing as is currently done, but how risks in one area combine with risks in another area to affect overall organisational risk.

Assessing risk according to these important interrelationships provides a clearer picture of opportunities and potential pitfalls than when one examines risk by each category alone. For example, if operational risk is at a relatively low level, then perhaps the level of risk associated with the investment portfolios can be increased.

Many organisations with lower operational risk are willing to take more interest rate risk through variable-rate debt financing. On the other hand, if an organisation is pursuing a large capital expenditure programme with attendant increased operations risk, a steady, reliable stream of income is likely called for.

In this ease, the investment portfolios might be positioned more conservatively so that unexpected results, particularly on the downside, are not experienced if income from operations cannot be counted on. Lower interest rates are a good thing from the point of view of debt issuance and interest costs. Variable-rate debt on its own introduces the organisation to the risk of higher interest rates in the future.

Critical link

When managing risk in organisations it’s important not to miss the link between operations and investment decisions. Organisations are simultaneously borrowers and lenders when they include bonds in their investment portfolios. One way to support a more integrated approach to investments and financing is to adopt a strategy that considers fixed-income bond investments as the organisation having a lending position and the organisation’s debt as being a leveraged position.

Put another way, debt can be thought of as a "short position" to offset bond investments. Although this model provides a useful starting point, organisations seeking to manage risk across all financial assets and liabilities need to consider not only the amount of leverage in their lending positions, but also ways their particular mix of long versus short choices affects their risk, and how these choices correlate with each other. The principle of looking at the asset and liability components of debt instruments together is important.

changing Approach

Many organisations have developed investment management policies that are based on a model that emphasises asset allocation, portfolio diversification, and investment. The key, however, is incorporating these investment management policies into a broader asset/liability management strategy.

This broader strategy should incorporate both an investment management policy and a liability management policy. It should give consideration to assets and liabilities, and the concept of interest rate management should be captured within and between these policies. In addition, integration of the operating plan is just as important as the inclusion of interest rate management for an organisation to have a successful overall asset/liability management strategy that meets the earnings and capital needs of the organisation.

The writer is an Investment Banker.
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