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Managing and understanding risk
Monty Claret
Posted: 15 May 2018 09:48:27(UTC)

Joined: 24/05/2015(UTC)
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I am interested in people's view of risk and reward.

A great deal of people on these forums talk about total returns, but this can be misleading. One person may have a higher return because they have taken far greater risk, however that risk maybe too high for the outperformance it makes.

I use as a starting point Trustnet's FE score, is this too simplistic?

How do you manage risk versus reward? Do you use standard deviation?

I look forward to hearing your views.

Dan L
Posted: 15 May 2018 13:43:36(UTC)

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I don't use any fixed measure like the FE score or standard deviation except for a quick glance. Those measures are too short term for me as they are based on 3 or 5 year periods which aren't really relevant to a long term investor. They tell you how volatile a particular fund or share is over recent times but nothing really about the future. Besides, i don't really care about volatility yet - maybe in 15 years or so I will. I would rather have a fund or share holding that drops or gains 10% a week to get me to 30% a year rather than one that steps up calmly to 15%.

So I basically do it on feeling (guesswork?). I know that equities have a higher risk of loss than bonds and that bonds have a higher risk of loss than cash. I also know that cash is almost guaranteed to not get me where I need to be due to inflation risk.

Within the scope of active funds, I try to read as much as possible about the fund manager/team and in high conviction funds I read about the high percentage company allocations. I try and make my own opinions from that. In most case I simply determine if i think that the fund manager can make me money with a lower risk of loss during an extended bear market or crash
3 users thanked Dan L for this post.
Keith Cobby on 15/05/2018(UTC), Mr Helpful on 15/05/2018(UTC), Aminatidi on 15/05/2018(UTC)
Mr Helpful
Posted: 15 May 2018 14:26:09(UTC)

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Monty Claret;62328 wrote:
I am interested in people's view of risk and reward.
How do you manage risk versus reward? Do you use standard deviation?
I look forward to hearing your views.

There are many types of risk, which the text books list.
But one thing it ain't IMHO is Volatility.
That use of Volatility for Risk stems from its' convenient availability for academic work.
For those with a 'Well Balanced Portfolio' and an 'Investment Plan', Volatility = Opportunity.
So the more volatility the better.
If not already read then maybe learn of the failings of the manic-depressive Mr Market (that's us folks!), in Ben Graham's 1950s book 'The Intelligent Investor'.

The 'Risk' that concerns this investor most is Valuation Risk; that interplay between :-
'Upside Potential' and 'Downside Risk'.
So for us, when markets seem fully valued Risk Assets (Stocks) are progressively dialled back; and Defensives (Bonds, Alternatives, Cash) progressively dialled up.
Then a reverse process as valuations subside.

While all this is going on at portfolio level, individual holdings will be tracing out their own various paths between attractive and expensive valuations and back, so will need individual attention.
2 users thanked Mr Helpful for this post.
Slacker on 15/05/2018(UTC), Monty Claret on 15/05/2018(UTC)
King Lodos
Posted: 15 May 2018 15:11:18(UTC)

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The relationship between risk and volatility can work quite nicely mathematically.

If the simplest way to double the market return is to buy the market with leverage, then (cost of borrowing excepted) you do get a linear relationship, where return doubles and volatility doubles .. Likewise adding cash has the sort of inverse effect.

Of course it's completely inadequate in other ways .. It's also time dependent .. A professional fund manager's career might be at risk from 3 years of underperformance; whereas a retirement investor might not even look at their stocks for 30 years .. A lot of edge in investing strategies is really an exploit of time-frame (whether yours can be significantly larger or smaller than the professionals')

Posted: 15 May 2018 15:26:08(UTC)

Joined: 06/01/2014(UTC)
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Continuing to stray slightly from OP question I too am less interested in the pseudo quant science of “Risk” ratings for funds.

As an investor I prefer to think the 3 Risks most relevant to consider when looking at a company (or companies comprising a fund) can be categorised as follows:-

Market Risk - is there one for its products or services and is it growing or contracting

Credit Risk - do they get paid for what they do or if i choose to buy their Bonds can I be confident that they won´t default

Operational Risk - do they manage the internal operations effectively or am I likely to have a large oil spillage, car recall or product failure that will wipe out half the company value.

There are plenty of overlaps and arguably some gaps with these 3 but as a start I think they provide a useful framework for thinking about Risk.
1 user thanked DJLW for this post.
Monty Claret on 15/05/2018(UTC)
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