Balancing risk and reward as investors

Balancing risk and reward as investors
  • Investment management
  • 3 minute read

Risk appetite is a poorly understood concept. Regardless of their attitude towards risk, the coronavirus crisis will have left many investors – from the most conservative to the avowedly adventurous – wishing they’d left their money in cash. While understanding an investor’s attitude to risk is crucial, what often matters more is their investment time horizon.

Christopher Godfrey-Faussett, managing director at Close Brothers Asset Management, explores how investors can approach risk.

What is risk?

We come from the principle premise that our remit is not only to grow, but to preserve capital for our clients. Ultimately, risk is the ability to withstand potential losses. On that front, risk is a bit like pain – our attitude towards it is highly subjective. People’s pain thresholds vary widely as do their tolerance to risk, but there are ways of quantifying risk tolerance.

Also, how you view risk will depend on your launch-pad. If you have plenty of assets behind you and your portfolio is only a small part of that asset base, then risk may be a much smaller consideration than if you’re investing your life savings. So when assessing risk appetite, there has to be an understanding of the client’s circumstances and goals.

Do you know your risk profile?

At Close Brothers, we have six different risk profiles, ranging from low risk to higher risk. “Low” is focused on lower-volatility investments such as bonds, while the higher-risk profile focuses on investing in shares. A medium-risk profile would offer a range of anything from 40% exposure to shares at the lower end, up to 80% at the higher end.

We have lots of clients who fit into one profile, but would want to be at the higher end of it from a risk point of view. Close Brothers isn’t a restrictive house. We offer portfolios tailored to each client’s needs, and for those with £1m+ investable assets, portfolios that are completely bespoke.

The three main forms of risk:

Client risk

Client risk refers to expectations. Within that lies their time horizon, what they’re trying to achieve, their understanding of market dynamics, what they’re planning for the future – projects, living expenses and income.Timeline is important. We are long-term investors. We prefer to invest over five to 10 years-plus, but in order to get any traction in the markets you need at least a three-year time horizon. If a client has a financial commitment in the shorter term, we have to say: “Don’t expose the cash you’re going to need to the markets.”

Portfolio risk

Whatever the client’s risk profile, you have to ensure that their portfolio is sufficiently diversified to weather any situation. That means understanding the fragility of your assets or indeed taking advantage of compelling investment themes that may arise, such as strongly-performing pharmaceutical or technology stocks.

You also want a sensible mix of investments in asset classes – whether these are bonds, hedge funds, gold, commodities, property or other alternative assets – that do not necessarily move in line with stock markets. If equity markets fall, the entire portfolio will not consequently follow. Plus, you want to have some flexibility with some cash on hand – firstly, as a defensive measure, and secondly so that you have the ability to invest in opportunities when they arise.

Stock risk

US investor Warren Buffett’s rule number one is: “Don’t lose money.” Rule number two? “Don’t break rule number one.”

You need a dynamic research team, like ours, to provide ideas and give you knowledge to build upon, so that you can be confident your chosen investments have management expertise, a strong balance sheet and sound cash generation to move forward in good times and weather the storm during difficult periods.

Close Brothers' Risk Monitoring System

An additional check and balance in ensuring a client’s portfolio continuously matches their risk profile is our in-house risk monitoring system. This gives us information and insight into the volatility to which we’re exposing the portfolio.

The monitoring flags anything that looks out of kilter with a client’s risk profile, and makes us justify why we’ve selected a particular investment if flagged. Our risk monitoring team is very thorough in their analysis of the investments we hold.

The importance of communication

Our ethos is based on knowledge, flexibility and communication – knowing what the client wants. We see communication as vital which is why we regularly speak and write to our clients. This provides reassurance – we are not talking about a general letter that comes blandly out of a computer, but talking to them directly. Because our bespoke investment service provides an investment manager with a low client ratio, we’re able to do that.

The feedback I have received from clients has been that they feel reassured and understand exactly how we are managing their investments in these volatile times. If you’re concerned about the risk of your portfolio, it’s worth getting in touch with investment professionals.

This article was first published in The Week and MoneyWeek, June 2020.

Your capital is at risk. Investments can go down as well as up. Past performance is not a reliable indicator of future returns.

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