Risk is the probability of not meeting investment objectives
Risk in an investment context is not so much about the volatility of asset prices as it is about the probability of your portfolio not meeting your investment expectations.
Herman Steyn, CEO of Prescient Investment Management, who was speaking at the group's investment presentation last week, stressed the importance of measuring and managing your risk.
"The problem with using standard deviation or volatility as a definition for risk is that this approach deems equities more risky than cash. In reality, cash could be the highest risk asset class because, if you add in inflation, cash has the highest probability of falling short of inflation.
"Traditional measures of risk tend to focus on the volatility of assets and do not provide a complete view because they don't take into account the actual risk faced by the client,” said Steyn.
Prescient Investment Management makes use of a risk benchmark, which provides the lowest level of return that an investor can accept, providing a framework against which the group can manage clients' investments in the most appropriate manner.
The risk benchmark encapsulates actual risk and changes over time as the needs of fund members change and as the fund gets closer to specific events that have been catered for.
Besides the risk of not beating inflation, retirement fund members also face the risk of having a shortfall at retirement between the value of their accumulated benefits and the cost of an annuity to fund an income in retirement.
In this regard, Daniel Acres, CEO of Prescient Life, said, "The products and investment strategies chosen in retirement impact the optimal investment strategy pre-retirement. As a result, investment strategies must take a ‘whole-of-life' view, and not create artificial disconnects at the point of retirement.”
In terms of generating the returns needed to meet client expectations, Prescient's approach is to construct a return benchmark to fund members' retirement income and bequest needs.
"However, the way in which we earn returns is as important as the returns themselves in that we need to earn the necessary return without taking on unnecessary risk at any point over the members' lives,” Acres said.
When constructing risk-appropriate portfolios, Prescient Investment Management's chief investment officer, Eldria Fraser explained that matching assets to liabilities involves taking into account the whole-of-life strategy of a client and not just the point of retirement.
"Therefore, the mix of assets in a portfolio must match the retirement income needs of the investor and also take into account the product they will use in retirement. A starting point of matching assets to liabilities can be strategic asset allocation (SAA), where you take the long-term asset class expectation into account.
"But, very importantly, this does not reflect current asset volatility, nor the price or value of the asset classes and therefore tactical asset allocation should be applied around the SAA. The mix of assets in a portfolio should adjust over the life of the investor and should match the portfolio they are retiring into prior to the date of retirement. As a result, an investor or fund member retiring into a guaranteed life annuity should have a very different asset mix to someone buying an investment-linked living annuity,” said Fraser.
Where risk-based tactical asset allocation is concerned, Fraser noted that derivatives like those used in most of the Prescient Balanced Funds are a great tool to manage downside volatility while still maintaining exposure to growth assets.
