Or Risk is the independent variable and Return, the dependent one.
Ever been on a car journey as a passenger where the driver was going too fast; being reckless; and essentially taking chances? Over and under-taking, switching lanes without looking, going too fast and braking too hard. We all have. It’s not so pleasant especially as you get older and realise how much is at risk from a needless mistake: your health, your life even; the realisation that family members depend on you staying healthy and not becoming a burden; your enjoyment from their growing old.
So, we try to avoid such a scenario. It’s relatively easy since reckless driving is usually associated with inexperienced younger members of society in fast cars. So, we can avoid such journeys as being readily identifiable in advance.
And yet we often find that a similar journey, multi-generational wealth investing, has older wealthy members indifferent to risk and unaware of the loss of wealth that occurs when insufficient attention is paid to the risk path taken by their managers.
Investing is not so different from a car journey? It’s a path to an end point with risk to be managed; speed, comfort, time horizon all matter for investing as much as they do for being driven. Better to get to the end point safely and aware of risks on the way, and how to drive defensively at such times, than to get there at speed dangerously?
And yet here we are, perhaps caused by years of unorthodox monetary policy, where many managers and clients perceive risk as irrelevant and an irritant? All focus is upon return – those ‘sexy’ growth stocks, that 10 bagger PE fund, that property that will inevitably benefit from a lick of paint or a change of use permission, and of course the free put option available to all investors that has been a feature of monetary policy in essentially the last 25 years.
So we’re going to bore you with a brief article on the independent variable known as risk. Return, the glamourous bit, is the dependent variable. No risk, no return. So, if you can’t define, measure, and manage risk then your returns are a function of luck. Not a lot of people know that.
We spend a lot of time obsessing about risk especially in multi-asset portfolios, whose Alphas and Betas are both correlated at different extents at different times, and where they offer differing opportunities for active and passive approaches at different times.