The strategic focus of financial executives and institutional investors must be risk intelligence, not just risk management, according to Leo Tilman, President of Tilman & Company, author, and adjunct professor of finance at Columbia University. He was the first speaker on May 28, 2013 at a webinar organized by the Global Association of Risk Professionals (GARP).

In the words of Peter Drucker, institutional investors must understand “the future that has already happened.” Tilman said investors need to have a vision for growth and relevance in the low growth, low return environment post-2007.

“Does a firm have a holistic framework for making strategic decisions?” Tilman asked. The language of risk intelligence underlies successful business models. To navigate turbulence, the organizational leaders need vision, dynamism, and alignment. He likened the boardroom to the cockpit of a jet in motion. (The accompanying figure shows a “radar screen view” from the cockpit.) “You must understand where you are going and know the right set of levers to pull.”

US fiscal and European debt crises loom. Environmental catastrophe, operational breakdown, and global imbalances threaten world order. According to Niall Ferguson, “the system is teetering on the edge of chaos.” In today’s hyper-connected world, there is “instantaneous transmission of shocks,” said Tilman. When faced with pressure on the margins, beware: a complex environment and the lack of buffer can lead to two types of behaviour.

In the first type, a firm takes on more complex investors, and a vicious cycle ensues when risk exposure increases but compensation declines.

In the second type of response, there is a “dynamic rebalancing of risk” by risk-intelligent organizations. Tilman emphasized the importance of understanding a firm’s exposure to each part of the vicious cycle. It requires risk intelligence and effective crisis management. Organizational vision should include risk within the six top corporate priorities. “We must reconcile return objectives with risk objectives.”

The key question then becomes “do we effectively deploy the entire arsenal of levers?”

Board decisions can and should be connected with risk intelligence, Tilman noted. However, “if you want your brand to reflect your risk intelligence, you cannot work in silos.” In order to factor in risk when making board decisions, it is important to aggregate risk with the other measurables. For example, there should be risk budgeting and reconciliation between the P/E targets and the risk appetite.

Tilman cited case studies of organizations that fared well during the financial crisis of 2007. “They had a culture of watching for early warnings—either a process or a culture or a habit. And they acted on it.” For example, they changed liquid asset allocations “or changed other levers available to them.”

Sometimes a firm does not have a good quarter. “It’s incredibly instructive to sit down with management to discuss their response [to not meeting targets],” said Tilman. The leaders have to discuss the next step, such as whether to capture market share or take on more risk. Reconciliation between risk and return was especially necessary. ª

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