Targeting Consistent Risk Tolerances

This month I attended a client’s audit committee meeting to review cash investment strategies and an interesting question was raised; the treasurer asked if it was time to start evolving their risk tolerance away from a Government-only strategy. This was a provocative question and one that we hear frequently these days.

Although this particular company has a broad, well-drafted investment policy that allows high-quality corporates and asset backed securities, a
Government-only strategy has been mandated since the credit crisis of 2008. The credit markets are in a markedly different place today than they were in 2008 and the migration of risk tolerance within one’s investment policy should reflect this reality. Still, rationalizing the process to an audit committee can present a challenge.

Last summer, we researched a large sampling of companies to determine how they were adjusting their cash investment strategies during a period of improving credit markets. Building upon that report, and to help support a thoughtful answer as to when and why companies should modify their risk tolerances, we suggest an alternate approach: instead of migrating risk tolerances in cash portfolios based on credit cycles, this month’s research examines how to keep risk tolerances constant throughout a credit cycle by applying the economic concept of “Constant Risk Aversion.” This research seeks to provide structure to the rhyme and reason of ever-evolving asset allocations that keep pace with changing economic environments. We hope that assigning additional methodologies to the task of managing cash investment risk will be helpful to those considering their own exposures.

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Best Regards,

Ben Campbell
President & CEO