When it comes to long-term investing, the key to achieving stable and lucrative returns lies in effective short to medium-term risk management.
Alongside consistent time in market, risk management is another crucial pillar that empowers an investor to achieve success in their investment journey and obtain the best risk-adjusted returns. Most investors tend to overlook the importance of risk management, neglecting even the most fundamental strategies. This lack of oversight has led to the collapse of financial institutions and severe economic downturns, all stemming from errors in quantifying and addressing risk.
It is fairly straightforward to assign a numerical value to risk, but the question lies in truly comprehending its implications. It’s like knowing there's an 80% chance of rain, which prompts us to carry an umbrella. We hope it doesn’t rain but it’s worth carrying the extra load.
How do you quantify the risk in your investments? How do you discern which assets can act as an anchor to your portfolio during turbulent times? How do you put it all together and effectively manage your risk ?. A recent example was when a new client came in with a portfolio containing a few mutual funds, with one mutual fund accounting for nearly 1/5th of their portfolio, lets call it ‘Fund A’
It is easy to identify parts of the portfolio that accounted for the performance and under-performance. However, the client was not aware of the concentration of risk in their portfolio. That ‘Fund A’ represented approximately 35% of the total risk in their portfolio, despite delivering a relatively average performance. The fund also had most of its underlying holdings concentrated between just a couple of sectors.
Our optimised recommendation suggested an alternate fund, lets call that ‘Fund Z’ that not only performed better historically, surpassing the existing fund by over 20%, but also exhibited a more well-diversified underlying holdings. Had our recommended ‘Fund Z’ been a part of their portfolio, it would have outperformed their portfolio by 13% while carrying nearly 15% less risk overall. Moreover, we could have balanced out their risk in the medium-term better by diversifying risk and building in a strong hedge by adding ‘Fund X' and 'Fund Y’.
By leveraging our ability to quantify, optimise and re-organise existing investments in your current portfolio, we can reduce the impact of ‘unnecessary risk’ and ensure that the risk being taken on is aimed at optimal risk-reward. While it may be easier to make investment decisions solely based on the performance of certain assets, the ultimate goal for achieving stable long-term returns is to make decisions that incorporate the potential cost of risk.
Connect with Berrywise for a free consultation - an in-depth portfolio analysis powered by Sentry.
Data: Berrywise-Sentry, risk calculated using Standard Deviation
