The assumptions that are used in incorporating alternative investments into enterprise risk analysis can have important consequences for the perceived risk within investors’ portfolios, according to a white paper from BNY Mellon.

Institutional investors have become more aware of the importance of risk management across asset classes.

Enterprise risk analyses, such as stress testing and scenario analyses are increasingly popular with institutional investors, whereas alternative investments, such as private equity, hedge funds and real estate present challenges to enterprise risk analysis.

Authored by BNY Mellon and its affiliate HedgeMark, the paper, Considering the Alternatives: A Practical Look at Enterprise Risk Analysis and Alternative Investments, explores the impact of incorporating illiquid or non-transparent investments into enterprise risk analysis.

The paper looks at how different approaches to data management can affect the resulting analysis, the associated benefits and issues, and offers solutions.

Frances Barney, Head of Consulting-Americas for Global Risk Solutions at BNY Mellon, said: "With a sharper focus on risk by regulators and other stakeholders, many institutional investors seek a fuller picture of how risk operates across investments within an entire portfolio."

"Data is getting more and more critical and investors need to be informed and comfortable with the assumptions of their risk assessment, otherwise, they can come out of it with a false sense of security about their portfolio," she said.

Enterprise risk includes the many factors that can affect an organization – market, reputational, regulatory, compliance, operational and legal risk.

The paper focuses on the risks inherent to an investment program with multiple asset classes owned by a single organization, such as a pension plan or a charitable foundation.

According to the findings, different approaches to data management can lead to different potential conclusions about the risks within an investment portfolio.

The paper also finds that using a single vendor to pull together an institution's total investment data enables a more uniform approach in calculating enterprise-wide risk and exposure, whereas data across multiple platforms adds to the complexity and likelihood of errors.

The paper reveals that many firms are establishing a separate chief risk officer function to supplement the risk management responsibilities inherent within the investment management functions.

Already some regulators require reports on stress testing and scenario analysis, such as Solvency II for insurance companies, and UCITS for European investment funds, said Barney.

These new risk management functions require a significant amount of data to enable evaluation of investment risks across asset classes.

Currency or country exposure is relevant for most investments, and liquidity is also a consideration for all investments, said Barney, adding that each of these measures provides insights into different aspects of investment risks, but the estimation and aggregation of these risks requires transparency into portfolios.

"We've learned the most crucial component is the veracity of the underlying data, which becomes even more important and difficult to manage as more opaque assets are held in the portfolio," she said.