RISK IS A FOUR LETTER WORD: FREE PORTFOLIO REVIEW OFFER

With interest rates rising, investors are focused on risk. Many are exposed to more risk than they think.

Often, when a new client join us, we find that their existing portfolio exposes them to significantly more risk than they tell us they are comfortable with, based on their risk tolerance. With interest rates rising, we believe many other Canadian investors are in a similar situation.

Why does this happen? There are a number of reasons. A growing body of evidence suggests that the sorts of people most likely to go into the lucrative financial service sales roles have personalities that are poorly suited to judging risk. Read more>>  In an effort to improve returns, many advisors put their clients into securities such as long-dated corporate bonds, preferred shares, and so-called ‘high income’ funds.

free portfolio review

Our free portfolio review will help you understand the quality of your current holdings; whether or not they meet your investment objectives and if they align with your risk tolerance.

These attempts to manage returns unfortunately expose clients to higher risk. When the US Federal Reserve signalled earlier this summer that it might begin to pull back on its quantitative easing programmes, interest rates jumped and fixed-income securities experienced sharp declines.

You can view 10 year Government of Canada Bond interest rates here>>

At Sprung Investment Management, our portfolio management approach is based on managing risk. We define risk as: “Your funds not being available when you, the client, needs them.”

What our clients really care about is having their funds available to meet their lifestyle requirements. However, in order to mitigate this risk, we do look at, and measure, many of the more traditional types of risk that can affect the outcome. In the remainder of this article, we will describe some of the common forms of risk and describe how they may influence your portfolio.

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Are you at risk? We are pleased to offer qualified* investors our free portfolio review. It will help you to understand if your investment risk matches your personal risk tolerance. Ask us how>>

*Canadian residents with a minimum $500,000 portfolio.

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Opportunity Risk

Opportunity risk can be described as the “what might have been if only I had known better” risk. It is the amount of gain foregone by not having perfect knowledge of what is going to happen. For instance, if you knew what stock was going to be the biggest gainer tomorrow, each and every day, you would sell your current holding at the end of each day and buy tomorrow’s winner.

Unfortunately, studies have shown that investors’ belief that they can ‘time’ the market is an illusion. Read more>>

In order to compensate for the lack of perfect knowledge, portfolios are diversified into a range of holdings in different industries, asset classes, countries, currencies, etc. Opportunity loss or gain can be measured as the difference between the value of the portfolio and the value it might have achieved if the assets had been arranged differently (typically, according to the benchmark (discussed later) being applied.

Benchmark Risk

When you establish a portfolio, you want to determine what your long term goals are and then design the portfolio to meet these objectives within your tolerance for risk (there’s that word again), usually thought of as your threshold for losses in any given period. As time progresses, it is desirable to establish a means by which you can measure the progress of the fund. Hence, Benchmarks are chosen for the fund as a whole and often many of the fund’s components.

For the fund as a whole, it is common to use either an Absolute Benchmark or a Relative Benchmark. An Absolute Benchmark can take the form of a desired rate of return such as 8.0% after fees or 3.0% above the period’s inflation rate, typically the Consumer Price Index. Relative Benchmarks take the form of the S&P/TSX Total Return Index for Canadian stocks, the S&P 500 for US stocks, the ScotiaCapital Universe Bond Index for Canadian fixed income, etc. The total fund is then measured by a composite of the asset class returns in a predetermined proportion.

Be careful what you wish for! Setting too high of an Absolute Benchmark may cause a manager to take on a higher risk (a greater chance of large loss) than you can tolerate. Relative Benchmarks have to be chosen carefully. For instance, the S&P/TSX Total Return Index is composed with Financials, Materials and Energy stocks making up over 70% of the index at this time. A few years ago one stock, Nortel, comprised over 30% of the index. Is this prudent or proper diversification for your needs?

Other Risks

Asset mix decisions result in a lot of taking on a host of risk factors that need consideration, at least by your portfolio manager but of which you should be at least aware. The decision to invest in multiple asset classes such as equities, fixed income and cash will not only affect the expected return pattern of your portfolio but also the degree to which the return will vary from that expectation. Decisions to enter into multiple markets within asset classes such as foreign fixed income or foreign equities will further impact the return pattern as well as introduce currency risk (the fluctuations between differing currency values). Your portfolio manager should be able to demonstrate what these added risks entail and how they may benefit or detract from your objectives.

Investing in particular markets also creates factors to consider. If you are indexing to a particular market (buying stocks or derivatives to mimic the return of a market index), you will want to consider the composition of that index (see Benchmark Risk). Even when investing in individual stocks in a market, you take on some of the risk of the market as a whole. This risk is often referred to as exogenous or systematic risk. To explain, think of the saying “A rising tide lifts all boats and a falling tide lowers all boats”. This is the risk that when the market enters a “bear” period, most stocks fall including those of very good companies. Each security carries its own “specific” risk often referred to as endogenous or unsystematic risk. This risk has more to due with the particular company in which you are investing in terms of its financial position, market leadership, etc.

Summary

Risk is a word much bandied about by industry professionals without trying to enunciate the meaning of the term to clients. Yet, an understanding of the various types of risk and the impact that it can have on meeting your objectives is fundamental to constructing a portfolio.

With interest rates rising, investors are re-evaluating their risk exposure. Does your portfolio include contain hidden landmines that could implode as rates rise? If you are not sure, our free, no obligation portfolio review will help you understand the quality of your current holdings; whether or not they meet your investment objectives and how well they align with your risk tolerance.

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Are you at risk? We are pleased to offer qualified* investors our free portfolio review. It will help you to understand if your investment risk matches your personal risk tolerance. Ask us how>>

*Canadian residents with a minimum $500,000 portfolio.

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