The importance of understanding and minimising risk as an investment belief

Whenever you invest your money, you are always taking on an element of risk.

For example, there is always a risk that an investment won’t perform as you’d like, and you will get back less than you put in (sometimes known as price risk). In the case of fixed income, the bond issuer could default. There is also always a risk that you won’t be able to access the money in a timely manner when you need it – or for a reasonable cost.

Different asset classes have different risk profiles. For example, shares in a large public company will likely be easier or quicker to sell compared to a property, but might be more affected by market volatility.

Regardless of the asset, it is impossible to totally remove all risks. Even the safest option, putting your money in a cash bank account, has risks. Only the first £85,000 per banking group is covered by FSCS protection, so anything over this amount is at risk in case of the banking group failing. One way to mitigate this could be to invest in a number of different banking groups – which we can help facilitate through the SJP Cash Deposit Service Powered by Flagstone.

With cash, there is also the risk that inflation will outstrip interest rates, reducing purchasing power by more than expected – something we’ve seen recently.

While it is natural to want to avoid any and all risks, Dr Andrew Drake, our Director of Risk and Controls, describes risk and reward as two sides of the same coin. He notes you need to understand and accept some risks to stand a chance of returns; and over the longer term, luck tends to net-off to reveal competency.

Risk reward

A general rule of thumb in investing is the greater the risk, the greater the potential for rapid returns.

For example, government bonds from developed economies are considered lower risk, as they are generally unlikely to default. But at the same time, they pay relatively low yields compared to riskier bonds, which tend to come from developing economies or companies with lower credit ratings.

Similarly in equities, a smaller, younger company has arguably more room for larger returns compared to an established player. But (assuming all else is equal) it is also much more likely to fail.

At SJP, the Investment Committee believe in always understanding the risks within an investment strategy and removing any risks we do not need or intend to take.

Balancing risk and return enables us to tailor an investment strategy to suit your needs.

Drake notes: “There are many types of investment risk, driven by myriad factors. Some represent opportunities for those with better information and skill; some can be traded or hedged directly; others may represent unavoidable consequences of the way markets behave or function. All types of risk can be understood and managed.

“Investment strategies generally succeed by exploiting inefficiencies in the market’s pricing of information and risk – by applying advantages and skill in finding and interpreting information to derive superior forecasts of the likely trajectories that securities may follow and engineering exposure to those with the most attractive gain (relative to current market price) in a measured and diversified manner. Sometimes the factors driving risk and returns are specific, more often they are common across subsets of the investment universe.”

Through careful risk management, we look to understand and steer intentional risk taking, while safeguarding against unintentional risks and possibilities for undesirable outcomes.

Controlling risks

Risk management is embedded throughout of our investment process, from choosing a fund manager, through to assessing our Portfolios.

Our multi-manager funds are good examples of this in action. Within each of these funds, different managers will be given individual investment objectives or strategies, providing slightly different risk factor exposures. We then blend these managers together within a fund, to create a desired risk profile.

We continuously monitor and control the composition and levels of risks in our funds to ensure they behave as expected, can withstand volatility, and remain on their intended risk-profile flight corridors.

While it is impossible to totally mitigate risk away, by continuously steering the risk profile towards appropriate blends and levels of intentional risks (where managers are expected to exhibit edge) and managing downside risks, effective risk management can benefit both the long-term expected risk and return outcome.

This is the fifth article exploring our seven investment beliefs. Click here for an introduction to the series.

The value of an investment with St. James's Place will be directly linked to the performance of the funds you select, and the value can therefore go down as well as up. You may get back less than you invested.

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