Hailing from the Metn region of Lebanon, Philippe Jabre’s career spans four decades, through which he has established himself as a prominent figure in international investment and asset management. Having worked at GLG Partners in London, a division of Lehman Brothers International (Europe), he is best known as the founder, CIO and CEO of Jabre Capital Partners.
This article will look at risk management at a basic level, exploring why it is integral to protecting wealth and helping it grow.
In finance, risk management centres around identifying potential downsides in investment decisions and deciding whether to accept those risks or to implement mitigatory measures. Financial risk management is a continual process, as risks can change over time.
All types of investment come with certain risks attached, albeit with some options being riskier than others. Take for instance US Treasury bills, which have an extremely low level of risk in comparison with investing in emerging-market stocks.
Successful risk management requires a fine balance between potential risks and potential rewards. In general, the riskier the investment the higher the potential return, placing the onus on prudent investors to diversify their portfolio to mitigate overall risk.
Risk can be quantified in both relative and absolute terms. Risk management involves analysing sources of risk and making choices about how to deal with it. It occurs in every area of finance; for example, a stockbroker using financial instruments such as futures or options to offset potential losses from other investments. Poor risk management can translate to severe consequences for investors, companies and the economy as a whole.
The Great Recession of 2007 to 2008 was triggered by the subprime mortgage meltdown which in turn stemmed from a failure by financial institutions to adequately manage risk. Banks were giving mortgages to customers without taking into account their income and credit ratings. Mortgages were then sold to investment firms, who repackaged and resold them to investors as mortgage-backed securities. This was profitable until an increase in mortgage default rates rendered mortgage-backed securities worthless.
Common risk management techniques include:
- Retention, investing with the ethos that risk is the price to be paid for the chance of achieving high returns
- Transferring, i.e. passing risk from one party to another, for example health insurance enabling consumers to transfer the risk of costly medical bills to an insurance company in return for payment of insurance premiums
- Sharing risk between two or more parties, e.g. insurance companies paying reinsurers to cover potential losses above stipulated levels
- Loss prevention and reduction, where risk is mitigated rather than eliminated completely by balancing volatile investments such as stocks against more conservative choices, e.g. bonds
- Avoidance, investing in only the safest assets, i.e. those that incur little to no risk
By understanding the financial risk landscape and implementing proactive measures, investors can stay ahead of potential threats, making insightful, informed investment decisions.
Financial risks take various forms, namely:
- Operational risks
- Credit risks
- Liquidity risks
- Market risks
- Legal risks
- Foreign exchange or currency risks
Key components in a financial risk assessment plan are risk identification, analysis, treatment and ongoing monitoring. Applying a financial risk management strategy has many benefits, enabling investors to identify potential risks, assess how much risk can be absorbed, and mitigate and control identified risks using a range of methodologies.
Financial risk is inherent in all investing activities. Although it is integral to growth and development, the results can be catastrophic where risk is inadequately managed. An effective risk management strategy identifies, assesses, mitigates, controls and monitors a wide range of potential risks. Knowing how to identify, assess and manage risk is a key competence for any investor and a critical aspect of safeguarding and growing wealth.
