The economic volatility that we have been experiencing from COVID-19 has reminded us that good planning and stress testing is vital to navigating turbulent times. Together, they help us be prepared when we enter into a poor scenario. A key strategy for our clients is the concept of enterprise financial risk analysis. It’s evident that this strategy is critical, more so now than ever.
I’ll share two examples of this risk exercise, one for a foundation supporting a public research university and one for a private university, which you may request below. Both have been fairly healthy and have bright futures, but, like many of you, both have had specific challenges in 2020.
So how does enterprise financial risk analysis work? In our examples, we focus on unique customized metrics relevant to their position, so that the organizations can see what the impact of certain market declines are on their overall financial health. This helps them in assessing how much risk to embed in their investment portfolios, as well as prudently plan out different forecasting scenarios at the enterprise level.
Add an additional layer of risk management
Let’s combine the prudent planning and stress testing exercise and overlay the concept of integrating the risks of the investment assets across the institution. Anywhere that a change in the asset values can impact a financial metric should be examined for various scenarios. This can be part of an initial and ongoing assessment of the risk embedded in your asset allocation decisions, and it can also be part of projections and budget forecasting when planning for future best, base and worst-case scenarios in revenues and expenses.
Why enterprise financial risk analysis matters
In the case of higher education, there are, as you well know, many moving parts, such as enrollment and revenue numbers, state appropriations and grants, fundraising initiatives, technology expenses and faculty-related costs. Looking at the portfolio from an enterprise risk level in order to forecast different scenarios based on various marketing conditions can help address those moving parts in your planning process.
How enterprise financial risk can impact your strategy and long-term planning
Consider the value of the endowment and other investment assets that are maintained for the benefit of the school, be it public or private. The risk embedded in these investments and that must also be stress tested across the financial health of the enterprise. For some public universities, certain state financial metrics can be a factor in the amount of state aid that is given. For many schools, maintaining the composite financial index (CFI) is a similar metric of certain financial ratios. All of these financial health assessments can effect credit ratings, cost of capital, debt covenants, reputation and strategic initiatives of the institution.
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Information provided by SEI Investments Management Corporation (SIMC), a registered investment adviser and wholly owned subsidiary of SEI Investments Company. Investing involves risk including possible loss of principal. There can be no assurance that your investment objectives will be achieved.