Alpha seldom arrives in a straight line, nor is it predictable. This unpredictability makes risk management a critical component of portfolio construction – helping to minimise errors, avoid unintended exposures and embed diversification – to ultimately smooth out the overall alpha gradient for enhanced long-term risk-adjusted returns. The importance of risk management in asset management is gaining traction with the Financial Sector Conduct Authority currently reviewing Board Notice 90 (BN90), to explicitly require asset managers to implement appropriate risk management systems in their portfolio management and construction processes.

This regulatory evolution comes at a pivotal moment for the industry, emphasising the increasing necessity of risk management. Just over three years ago, offshore investment limits were adjusted from 30% to 45%, giving South African investors access to broader opportunity sets and enhanced global diversification options. Currently, a significant number of leading managers in South Africa still hover well below the 30% offshore exposure mark within their client portfolios.

There are various ways to interpret the reason for this, including manager bias based on perceptions around the inherent and compelling value offered by local investment opportunities. Or could it simply be due to a lack of risk management to help determine the optimal offshore exposure for these managers?

Risk: a value card

In the current environment, where the search for alpha continues to be central to our client promise, we need a more nuanced understanding of what risk management is, what it is not, and how it can be leveraged to enhance value.

To illustrate, there are 780 pairwise relationships in a portfolio of 40 stocks. While it might be easier to understand the first few stocks’ risk impact on each other, it is far more intricate to understand the interplay between the first and the fortieth stock. Therefore, understanding risk to alpha in today’s volatile markets requires moving beyond simplistic assessments of individual stock volatility toward a holistic view of how positions interact, complement, and occasionally concentrate risk in unexpected ways.

Rebranding risk management

Risk management is often labelled as the conservative twin of portfolio management: necessary, technical and at times, restrictive. A popular analogy about the role of risk managers in the investment process is that of a guardrail – a protective barrier that stops investment managers from running off the road or taking a curve too quickly. Yes, risk managers will always serve a preventative and defensive function, which aligns with the investment manager’s aim of avoiding the loss of capital, but that’s not the full story.

The complexity of modern investing means that risk management’s role is no longer an afterthought or a mere compliance tick box. It must consider more than the risk universe; it must also be grounded in the return expectations presented to clients and the initial discussions about the desired investment outcomes. When clients are promised specific results, achieving those benchmarks becomes the goal against which all decisions are measured. Failing to deliver promised returns itself constitutes significant risk, one that excessive conservatism can inadvertently create. The answer is to adopt a considered strategy of taking deliberate risks along the way.

By way of example, consider the current levels of market uncertainty, which are bubbling over due to an unclear tariff environment, global conflicts, political instability in some regions, and sluggish growth forecasts. Faced with these headwinds, portfolio managers are, understandably, concerned about any possibility of capital loss. As a result, some reflexively “play it safe” rather than harnessing active, data-led risk management to guide their decision-making.

While understandable, playing it safe may, itself, introduce risk. When excessive caution leads to reduced positioning, it can jeopardise client outcomes. This is precisely where sophisticated risk management principles can add value, helping to pinpoint areas of underinvestment or overinvestment that could negatively impact alpha generation.

Balancing risk and allocation is also about being willing to challenge potentially latent risks, such as being underweight traditionally defensive assets like gold during periods of uncertainty or querying the rationale of simply following peers and piling into a popular stock, without considering alternative options offering similar defensive characteristics in different sectors. It might even mean advocating more risk when portfolios are insufficiently positioned to achieve a client’s stated objectives.

Behind the scenes

These conversations are complex and sometimes uncomfortable, but it is not only appropriate but also essential that a natural tension exist between portfolio managers and risk managers. Our role as risk managers must be to consider a range of stress-tested scenarios and present clear, risk-focused perspectives that identify potential bumps in the road ahead to better facilitate portfolio managers’ generation of alpha.

By constantly advocating the fulfilment of the client promise, we can reset the risk overview as it relates to the portfolio design and construction. If risks are not yielding results, then it is our responsibility to find deliberate ways of levering risk to unlock reward. If a specific portfolio is not fully harnessing the power of diversification, we must interrogate our positioning decisions.

Sometimes this might mean advocating more risk. This may seem contrary to the notion of risk management as a guardrail, but it is an approach that keeps the spotlight on risk throughout the lifespan of a portfolio, from the design and to the execution of a portfolio’s strategy. This approach transforms risk managers from passive monitors to active contributors in the alpha generation process.

Executing risk management with rigour and discipline

In an era of compressed returns and heightened volatility, risk management must evolve from a defensive necessity to a genuine competitive advantage. Firms that can intelligently take risk by quantifying it accurately, diversifying it effectively, and adapting it dynamically will systematically outperform those anchored to old ways of risk management.

When risk management is executed with rigour and discipline, it liberates portfolio managers to pursue alpha generation confidently, secure in the knowledge that robust processes and multilayered oversight protect client capital, while enabling the deliberate risk-taking necessary for superior outcomes.

Modern risk management does not merely prevent disasters – it actively identifies opportunities, challenges complacency, and ensures that every basis point of risk taken is deliberate, diversified, and aligned with the client promise.