I typically tell the students who attend our Fundamentals of Performance Measurement course that risk is the most challenging aspect of our industry. We can’t agree on what it means or how to measure it. And while many today see risk as either being the potential for loss or inability to meet an objective, most of our risk measures actually measure volatility.
Because risk is so difficult to get ones arms around, it needs to be approached from multiple directions, so as to get the best picture possible of what we’re facing. In addition to typical risk measures such as standard deviation, tracking error, and beta, and risk-adjusted measures such as Sharpe ratio, Information ratio, and M-squared, we should consider other aspects of risk, too.
In spite of its challenges, Value at Risk (VaR) provides us useful information. Liquidity risk is another measure one should be assessing. At last month’s PMAR Europe, Jose Menchero discussed “extreme risk,” which can be seen as a complement to VaR.
Failing to properly assess risk is risky: looking at it from multiple angles is one way to gain some insights into what’s going on.