Page 105 - Profile's Unit Trusts and Collective Investments 2021 issue 2

Investment Risk

Chapter 6
Investment Risk
Investment Risk

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Relevant to
Superior investment returns cannot be achieved without taking on risk. 119917: 1, 4
Identifying how much risk (and what kind of risk) is worth taking on is the key 242594:1-4
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to successful asset management. The most fabulous returns can be achieved 243130: 1, 4
243148: 2, 5
by having all your eggs in one basket – provided you choose exactly the right
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basket. But picking the right basket is notoriously difficult, and for this reason
diversification is a widely accepted strategy for reducing risk. Too much
diversification leads to mediocre returns, however, and badly implemented diversification
can be self-defeating.
Another basic principle of investment is to match the financial needs of the investor with the
risk/return profile of the investment. The investments appropriate to each person vary according
to the investment term, income, available capital and even the emotional resilience of the investor.
CIS managers have designed investment products to meet a broad range of investment needs and
objectives, and this proliferation of products creates many more permutations along the
risk/return and diversification continuum. But to understand the pitfalls and benefits associated
with different products, a general understanding of investment risk is essential.

What is Risk?
There is no one definition of risk and no one answer to the problem of managing risk.
For some, “risk” is synonymous with the threat of loss. For these people an investment is risky
if there is any chance of a decrease in the value of the starting capital. Some individuals think of
“risk” as the prospect of total loss.
For others, risk is another word for unpredictability. This is closer to the formal definition of
risk, where a risky investment is one with an uncertain (but not necessarily negative) outcome.
There are even people for whom the word risk evokes excitement and opportunity.
Where risk is a fear of loss the investment objective is often protection of capital, which,
conventionally, usually means conservative low-return investments. But this approach carries
another risk: inflation risk, the risk of losing value in real terms.
Interestingly, there is a connection between education and risk appetite. As a rule, people who
have studied and understood the financial markets are more likely to accept a certain level of risk.
Paradoxically, this often leads to better returns.
The unit trust industry is rightly concerned with measuring risk and finding ways to match
investors with appropriate investments. This endeavour is complicated by shifting sands: the risks
of different asset classes are not consistent over time and the circumstances of investors are
changeable. Appropriate, conservative investment advice often condemns the investor to poor
returns.
In this chapter, against the background of these difficult questions, we examine the nature of
risk, the methods used to measure risk, and the choices faced by advisors and investors.
Risk Assessment

Many management companies, LISPs (platforms) and independent brokers have designed risk
assessment forms which look something like the questionnaires included in this chapter (the Risk
Profile Worksheets). Advisors use these forms to evaluate the risk appetite of their clients so that
they can match the client’s risk profile with a range of appropriate investments.

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