InvestmentsAug 2 2021

How to manage risk in a client's portfolio

  • Describe some of the challenges relating to risk in a client's portfolio
  • Explain how to diversify a cleint's portfolio
  • Identify how risk impacts a client's portfolio
  • Describe some of the challenges relating to risk in a client's portfolio
  • Explain how to diversify a cleint's portfolio
  • Identify how risk impacts a client's portfolio
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How to manage risk in a client's portfolio
Pexels/Anna Nekrashevich

You would presume that less experienced investors tend to be more risk averse given they are new to the game and may want to dip their toes in first, but evidence suggests this is not the case. 

Recent research from the FCA found that nearly two thirds of new investors reported that a significant investment loss would have a fundamental impact on their current or future lifestyle, yet two-fifths did not even view ‘losing money’ as one of the risks to investing.   

This is where the value of an adviser really comes through. People’s perception of risk and how their portfolio is positioned are often way out of line. Whether that is someone nearing retirement with a portfolio of high-growth tech stocks; or someone in the early 40s leaving their savings entirely in cash and government bonds, advisers have an important role in teasing out clients' risk profiles and taking risk from a matter of subjectivity to one of objectivity. 

How does risk impact asset allocation? 

The beauty of financial markets, much like the Olympics, is that there really is something for everyone. 

There are ‘set and forget’ investors favouring diversified multi-asset portfolios, and highly leveraged day traders ‘playing the markets’ and everything in between. 

Advisers most likely would, and indeed should, question whether leveraged day trading is true investing as opposed to pure speculation, but the point is that financial markets can deliver wherever one sits on the risk spectrum. 

While the past is no predictor of the future, it is a very powerful indicator of what sort of returns and what sort of risk you should expect from various asset classes. The asset class universe can be divided into three main building blocks. 

  1. Low-risk liquid assets: These include government bonds, high-quality corporate bonds and cash. These assets provide greater capital security than other assets and are therefore considered to be less risky, but the returns will be lower. 
  2. Higher-risk liquid assets: These include equities and lower-grade corporate bonds, private equity funds, industrial commodities and hedge funds. These assets have a track record of delivering higher long-term returns, but they do carry more risk. 
  3. Diversification assets: Balancing the two components above, diversification assets act as a stabiliser in times of market stress and can include commodities, precious metals, property and other assets negatively correlated to equities and bonds. 

The individual’s risk profile will determine the proportion of each of these three components that will make up their portfolio. For example, someone wanting to secure capital growth may go for a portfolio of 85 per cent in equities, 10 per cent in alternatives and 5 per cent in cash and fixed interest. 

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