Managing The Risks – Risk Management

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9 Steps to Managing Risk for Your Project

Risk and uncertainty are inherent parts of all project work. Which is why so many projects—especially large technology projects—run into trouble. When studies tell us that easily half of all IT projects run over budget and past deadline, we see how easily risk turns into real trouble for projects and their organizations.

But there are ways you can mitigate and manage risk. When teams have a good risk management process in place, then you can identify and deal with all the project’s risks in an appropriate and thorough manner. When you’re good at managing risk, it means that fewer issues crop up and that you’re prepared for all eventualities. (And, people start asking for you to run their projects!)

Here are nine risk management steps that will keep your project on track:

1. Create a risk register

Create a risk register for your project in a spreadsheet. Include fields for date of the risk being logged, risk description, likelihood, impact, owner, risk response, action, and status.

2. Identify risks

Brainstorm all current risks on your project with the project’s key team members and stakeholders. Go through all the factors that are essential to completing the project and ask people about their concerns or any potential problems. Identify risks that relate to requirements, technology, materials, budget, people, quality, suppliers, legislation, and any other element you can think of.

3. Identify opportunities

When you identify risks, also factor in positive risks and opportunities. For example, include all events that in some ways could affect your project in a positive manner. What would the impact be, for instance, if too many people turned up to the concert? What could you do to exploit this opportunity and plan for it? Just as you anticipate and plan for problems, prepare for unlikely successes.

4. Determine likelihood and impact

Establish how likely the risk is to occur (on a scale from 1-5) and determine the impact of each risk according to time, cost, quality, and even benefits if it were to occur (again on a scale from 1-5). For example, a likelihood of five could mean that the risk is almost certain to occur, and an impact of four could mean that the risk would cause serious delays or significant rework if it were to happen.

5. Determine the response

Focus your attention on those risks that have the highest potential impact and likelihood of happening (i.e., an estimate of three or more on the scale mentioned in No. 4). Identify what you can do to lower the likelihood and impact of each risk. To lower the impact, get to the root cause by asking why, why, why?

6. Estimation

Once you’ve determined what you’ll do to address each risk, estimate how much it will cost you to do so. For example, using the concert example—how much will it cost to look after the performer’s health before the show, and how much will it cost to prepare for a backup? Provide a range of estimates (best case/worst case) and add the aggregated cost of these risk responses to your overall project estimate as a contingency.

7. Assign owners

Assign an owner to each risk. The owner should be the person who is most suited to deal with a particular risk and to monitor it. Assign risk owners with involvement from your team and stakeholders to get the best possible buy-in. Collaborate on the best possible actions that need to be taken, and by when.

8. Regularly review risks

Set aside time at least once a week to identify new risks and to monitor the progress of all logged items. Risk management is not an exercise that only happens at the beginning of the project, but something that must be attended to in all of the project’s lifecycles.

9. Report on risks

Make sure that all risks with an impact and likelihood of four-and-higher (on the 1 – 5 scale; see No. 4) are listed on your status report. Encourage a discussion of the top 10 risks at steering committee meetings so that executives get a chance to provide input and direction.

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Susanne Madsen is a Project Management Leadership Coach, and author of The Project Management Coaching Workbook (2020) and The Power of Project Leadership (2020). She is a PRINCE2 and MSP Practitioner and a qualified Corporate and Executive Coach. Susanne is a member of the Association of Project Management (APM) and has over 17 years’ experience in leading large change programs for the financial sector. You can visit Susanne’s website at http://www.susannemadsen.com and follow her on Twitter: @SusanneMadsen.

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Project Management: Rules For Managing Risks

Managing Project Risk

Managing project risk is an inevitable part of a project. Risks exist for various reasons, such as inaccurate scope definition and management, unforeseen circumstances, and ineffective stakeholder management. As a matter of fact, project management risk can crop up from practically any project process. Follow these simple project management risk rules to ensure success with your project:

  • Make managing project risk a recurring process
  • Analyze and prioritize project risks
  • Track project risks

Here’s to more effective project management risk and a less turbulent project!

Rule 1: Make It a Recurring Process

During Project Kickoff, to reduce project management risk, you document project risks and make a list of risk mitigation strategies in a Risk Register. The risks identified will vary from project to project. However, the Risk Register will always need to be created at the start of a project. This is a critical aspect of managing project risk.

Use the SWOT Analysis tool to identify risks during Project Kickoff. You’ll use the identified risks to create appropriate project plans. When the project is executed, do not forget about the Risk Register. As a project manager, you are expected to update the Risk Register as the project progresses. This is what managing project risk is all about.

  • Block your time once a week to review and update the Risk Register. This will reduce project management risk.
  • Gather project risks from team members in the daily team meeting. This will help to train them in proactive project risks identification. Your team can help you reduce project management risk.
  • Review the Risk Register with all stakeholders frequently. If you are following Agile Project Management practices, then an Iteration Kickoff can be used to identify project risks. Some project management methodologies have processes that are very effective in reducing project management risk.

Managing project risk is a daily, 24X7 activity for the Project Manager.

Rule 2: Prioritize and Re-Prioritize

If you follow Rule 1, managing project risk should be a part of your project’s DNA. If all goes well, you will have a litany of project risks coming from various stakeholders. Not all project risks are equally dangerous or good (remember there are ‘good’ risks, also known as opportunities); therefore, risk prioritization is necessary to successfully reduce project management risk. This is where managing project risk by risk quantification comes in handy.

To quantify project risks, assign each risk a value out of 4 based on the probability of the risk occurring and the impact of the project risk on the project. For example, suppose you have identified the following project risks:

  1. Project Management Risk 1: The vendor will not be able to deliver on time given labor problems.
  2. Project Management Risk 2: The client’s requirements will keep developing as the project progresses.

For managing project risk, look at the first project risk, the probability of occurrence may be low if the vendor is located in a country that has few labor problems. However, the impact on the project will be high when the risk is materialized. Therefore, the project risk would be classified as high with a value of (3). You can manage project risk choosing a vendor in a location that does not have labor problems.

Now, looking at the second project risk, the probability of occurrence is high and so is the impact. Therefore, managing project risk would involve assigning this risk the highest value (4). One way to mitigate this risk would be to use Agile Project Management practices. This will help you reduce project management risk and you’ll be more effective in managing project risk. Hopefully the Cost Performance Index and Schedule Performance Index will both show healthy project performance.

Note: There are several other techniques used for managing project risk by risk quantification, which have not been discussed in this article.

Rule 3: Tracking

Managing project risk by tracking is about not losing focus. In the Risk Register, you would have mentioned a mitigation strategy for each risk. Managing project risk is more effective if this strategy is implemented so that the project risk doesn’t surface. It is important to track all tasks associated with the risk mitigation to closure. This ensures reduced project management risk. It is similar to how you would track other project tasks and activities to closure.

By following these risk management rules, your project will have reduced project management risk and you will be less likely to modify the Project Network Diagram (Precedence Diagram) during the course of the project.

Risk Management in Finance

In the financial world, risk management is the process of identification, analysis and acceptance or mitigation of uncertainty in investment decisions. Essentially, risk management occurs when an investor or fund manager analyzes and attempts to quantify the potential for losses in an investment, such as a moral hazard, and then takes the appropriate action (or inaction) given the fund’s investment objectives and risk tolerance.

What is Risk Management?

What is Risk Management?

Risk management occurs everywhere in the realm of finance. It occurs when an investor buys U.S. Treasury bonds over corporate bonds, when a fund manager hedges his currency exposure with currency derivatives, and when a bank performs a credit check on an individual before issuing a personal line of credit. Stockbrokers use financial instruments like options and futures, and money managers use strategies like portfolio diversification, asset allocation and position sizing to mitigate or effectively manage risk.

Inadequate risk management can result in severe consequences for companies, individuals, and the economy. For example, the subprime mortgage meltdown in 2007 that helped trigger the Great Recession stemmed from bad risk-management decisions, such as lenders who extended mortgages to individuals with poor credit; investment firms who bought, packaged, and resold these mortgages; and funds that invested excessively in the repackaged, but still risky, mortgage-backed securities (MBS).

  • Risk management is the process of identification, analysis and acceptance or mitigation of uncertainty in investment decisions.
  • Risk is inseparable from return in the investment world.
  • A variety of tactics exist to ascertain risk; one of the most common is standard deviation, a statistical measure of dispersion around a central tendency.
  • Beta, also known as market risk, is a measure of the volatility, or systematic risk, of an individual stock in comparison to the entire market.
  • Alpha is a measure of excess return; money managers who employ active strategies to beat the market are subject to alpha risk.

How Risk Management Works

We tend to think of “risk” in predominantly negative terms. However, in the investment world, risk is necessary and inseparable from desirable performance.

A common definition of investment risk is a deviation from an expected outcome. We can express this deviation in absolute terms or relative to something else, like a market benchmark.

While that deviation may be positive or negative, investment professionals generally accept the idea that such deviation implies some degree of the intended outcome for your investments. Thus to achieve higher returns one expects to accept the more risk. It is also a generally accepted idea that increased risk comes in the form of increased volatility. While investment professionals constantly seek, and occasionally find, ways to reduce such volatility, there is no clear agreement among them on how this is best to be done.

How much volatility an investor should accept depends entirely on the individual investor’s tolerance for risk, or in the case of an investment professional, how much tolerance their investment objectives allow. One of the most commonly used absolute risk metrics is standard deviation, a statistical measure of dispersion around a central tendency. You look at the average return of an investment and then find its average standard deviation over the same time period. Normal distributions (the familiar bell-shaped curve) dictate that the expected return of the investment is likely to be one standard deviation from the average 67% of the time and two standard deviations from the average deviation 95% of the time. This helps investors evaluate risk numerically. If they believe that they can tolerate the risk, financially and emotionally, they invest.

For example, during a 15-year period from August 1, 1992, to July 31, 2007, the average annualized total return of the S&P 500 was 10.7%. This number reveals what happened for the whole period, but it does not say what happened along the way. The average standard deviation of the S&P 500 for that same period was 13.5%. This is the difference between the average return and the real return at most given points throughout the 15-year period.

When applying the bell curve model, any given outcome should fall within one standard deviation of the mean about 67% of the time and within two standard deviations about 95% of the time. Thus, an S&P 500 investor could expect the return, at any given point during this period, to be 10.7% plus or minus the standard deviation of 13.5% about 67% of the time; he may also assume a 27% (two standard deviations) increase or decrease 95% of the time. If he can afford the loss, he invests.

Risk Management and Psychology

While that information may be helpful, it does not fully address an investor’s risk concerns. The field of behavioral finance has contributed an important element to the risk equation, demonstrating asymmetry between how people view gains and losses. In the language of prospect theory, an area of behavioral finance introduced by Amos Tversky and Daniel Kahneman in 1979, investors exhibit loss aversion. Tversky and Kahneman documented that investors put roughly twice the weight on the pain associated with a loss than the good feeling associated with a profit.

Often, what investors really want to know is not just how much an asset deviates from its expected outcome, but how bad things look way down on the left-hand tail of the distribution curve. Value at risk (VAR) attempts to provide an answer to this question. The idea behind VAR is to quantify how large a loss on investment could be with a given level of confidence over a defined period. For example, the following statement would be an example of VAR: “With about a 95% level of confidence, the most you stand to lose on this $1,000 investment over a two-year time horizon is $200.” The confidence level is a probability statement based on the statistical characteristics of the investment and the shape of its distribution curve.

Of course, even a measure like VAR doesn’t guarantee that 5% of the time will be much worse. Spectacular debacles like the one that hit the hedge fund Long-Term Capital Management in 1998 remind us that so-called “outlier events” may occur. In the case of LTCM, the outlier event was the Russian government’s default on its outstanding sovereign debt obligations, an event that threatened to bankrupt the hedge fund, which had highly leveraged positions worth over $1 trillion; if it had gone under, it could have collapsed the global financial system. The U.S. government created a $3.65-billion loan fund to cover LTCM’s losses, which enabled the firm to survive the market volatility and liquidate in an orderly manner in early 2000.

Beta and Passive Risk Management

Another risk measure oriented to behavioral tendencies is a drawdown, which refers to any period during which an asset’s return is negative relative to a previous high mark. In measuring drawdown, we attempt to address three things:

  • the magnitude of each negative period (how bad)
  • the duration of each (how long)
  • the frequency (how often)

For example, in addition to wanting to know whether a mutual fund beat the S&P 500, we also want to know how comparatively risky it was. One measure for this is beta (known as “market risk”), based on the statistical property of covariance. A beta greater than 1 indicates more risk than the market and vice versa.

Beta helps us to understand the concepts of passive and active risk. The graph below shows a time series of returns (each data point labeled “+”) for a particular portfolio R(p) versus the market return R(m). The returns are cash-adjusted, so the point at which the x and y-axes intersect is the cash-equivalent return. Drawing a line of best fit through the data points allows us to quantify the passive risk (beta) and the active risk (alpha).

The gradient of the line is its beta. For example, a gradient of 1.0 indicates that for every unit increase of market return, the portfolio return also increases by one unit. A money manager employing a passive management strategy can attempt to increase the portfolio return by taking on more market risk (i.e., a beta greater than 1) or alternatively decrease portfolio risk (and return) by reducing the portfolio beta below 1.

Alpha and Active Risk Management

If the level of market or systematic risk were the only influencing factor, then a portfolio’s return would always be equal to the beta-adjusted market return. Of course, this is not the case: Returns vary because of a number of factors unrelated to market risk. Investment managers who follow an active strategy take on other risks to achieve excess returns over the market’s performance. Active strategies include tactics that leverage stock, sector or country selection, fundamental analysis, position sizing, and technical analysis.

Active managers are on the hunt for an alpha, the measure of excess return. In our diagram example above, alpha is the amount of portfolio return not explained by beta, represented as the distance between the intersection of the x and y-axes and the y-axis intercept, which can be positive or negative. In their quest for excess returns, active managers expose investors to alpha risk, the risk that the result of their bets will prove negative rather than positive. For example, a fund manager may think that the energy sector will outperform the S&P 500 and increase her portfolio’s weighting in this sector. If unexpected economic developments cause energy stocks to sharply decline, the manager will likely underperform the benchmark, an example of alpha risk.

The Cost of Risk

In general, the more an active fund and its managers shows themselves able to generate alpha, the higher the fees they will tend to charge investors for exposure to those higher-alpha strategies. For a purely passive vehicle like an index fund or an exchange-traded fund (ETF), you might pay 15 to 20 basis points in annual management fees, while for a high-octane hedge fund employing complex trading strategies involving high capital commitments and transaction costs, an investor would need to pay 200 basis points in annual fees, plus give back 20% of the profits to the manager.

The difference in pricing between passive and active strategies (or beta risk and alpha risk respectively) encourages many investors to try and separate these risks (e.g. to pay lower fees for the beta risk assumed and concentrate their more expensive exposures to specifically defined alpha opportunities). This is popularly known as portable alpha, the idea that the alpha component of a total return is separate from the beta component.

For example, a fund manager may claim to have an active sector rotation strategy for beating the S&P 500 and show, as evidence, a track record of beating the index by 1.5% on an average annualized basis. To the investor, that 1.5% of excess return is the manager’s value, the alpha, and the investor is willing to pay higher fees to obtain it. The rest of the total return, what the S&P 500 itself earned, arguably has nothing to do with the manager’s unique ability. Portable alpha strategies use derivatives and other tools to refine how they obtain and pay for the alpha and beta components of their exposure.

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