We Need an Institutional Risk Measurement Questionnaire

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With risk tolerance being tested for the first time in a decade, investors are reconsidering their risk appetites. Advisors have a plentiful choice of tools to assess investor risk tolerance. But the same isn’t true on the institutional side.

The COVID-19 crisis has, among other things, roiled the major stock and bond markets around the world. We’ve had several days in a row of wild gyrations, exceeding +/- 5% for major U.S. and global equity indexes. In fact, nine of the 10 trading days in the first half of March had close-to-close moves of 3.7 standard deviations or more. On three days, the moves exceeded 10 standard deviations. On the bond side, we’ve seen a rally in long term Treasury rates to unprecedented levels and then a plunge. Since then, there’s been a recovery – all in the course of a month. At the same time, we’ve seen spreads for lower grade bonds rise suddenly.

Amid all these moves, we also encountered seismic shifts in the oil market. An oil price war has broken out between Saudi Arabia and Russia, apparently in retribution for Russia’s unwillingness to reduce production in line with OPEC. Both producers seem intent on forcing the other to blink first and, in the meantime, oil prices have spiraled downward to well below production costs for most of the producing nations. The COVID-related fluctuations when the oil market encountered a political contest compounded the market turmoil and the stress visited on investors.

On the retail side, risk tolerance/appetite measurement tools typically seek to explore several variables that are thought to relate to personal differences in tolerance and capacity to sustain risks. Not all tools cover all of these categories, of course:

  • Age and investment time horizon
  • Experience with investments
  • Personal investment objectives and degree to which they are specifically defined
  • Relationship between assets and obligations
  • Relationship between assets and annual cash flows
  • Tax considerations
  • Personality-related ability and willingness to tolerate investment stress
  • Anxiety associated with investment losses

Broadly, we might think of the sections of a typical questionnaire as attempting to address the individual’s technical and logistic capacity to withstand negative market events and their demographic- and personality-driven willingness to do so.

Similar assessments might also be useful for institutions, including defined-benefit pension plans, OPEB plans, not-for-profit organizations, and institutional trusts. It is important for them to reassess their capacity to withstand adverse markets as well as their institutional tolerance for risk. With that in mind, I searched to find tools that could help advisors have a risk-appetite conversation with the committees responsible for those assets.