www.wealthandfinance-news.com 38 Wealth & Finance International - Issue 4 2018 Risk is inherent in the investment world, in any investment you make. My previous article explained that it was simply not possible to have NO risk. Where investments are concerned, it’s a question of how much risk you are prepared to take, not whether you take any risk at all. Also, we established that there was a direct correlation between risk and reward. The conclusion was that it is generally the case that when the potential risk is greater, so is the potential reward. However, over the past 20 years or so, it has become much more popular for individuals to invest in vehicles that ‘pool’ their money with that of other individual investors, rather than just investing in a single savings account with a single bank or a single company share, such as BP or Rolls Royce. Anyone whose bubble burst in the dotcom explosion, and indeed anyone who’s ever read the disclaimer that accompanies any investment proposition, will know that values can go down as well as up. As such, relying on the success of a single investment, like company shares, gives you nowhere to go if things take a plunge. An investment pool on the other hand, which not only combines your cash with other people’s cash but also tends to invest in many different areas, will reduce your individual exposure. Each of those different investments are also likely to go up and down, but the important thing is that they are less likely to go up and down all at the same time. A simple example of an investment pool would be a lottery syndicate. An individual playing a single ticket in the UK Lotto is almost 4,000 times more likely to win an Oscar, than land the lottery jackpot. Here, the reward may be great, but the risk on your investment is enormous. Yet when lots of individuals each buy a ticket and agree to share any joint proceeds, while the winnings would be divided, your chances of winning multiply. Thus, lower risk for lower reward. This pooling approach is something that is used throughout the investment world in both individual investment vehicles – for example, unit trusts, investment trusts, Open-Ended Investment Companies (OEICs) - and also by investment managers such as Clear CM. The strategy is called diversification. Diversification effectively means not putting all your eggs into one basket. By dividing your eggs among many baskets, if one of those baskets breaks you can still make your dinner! Clear CM sees diversification as one of the key ways of reducing risk within its portfolios. By keeping both risk and volatility to a minimum, the firm is adhering to its policy of promoting longer- term investment outlooks rather than quick wins (or losses!). We look to hold diversified investment vehicles within our portfolios, like units trusts or OEICs, though we also look to maximise that diversification further by investing in multiple vehicles from multiple companies. In addition to that, the different investment vehicles we select are typically invested in different assets or geographic locations. For example, we have some investment vehicles that may invest in UK companies, others that invest in companies in Europe, North America or Asia, or maybe investments in commodities (gold) or corporate bonds. Now, as any investment manager will tell you, no two clients are the same. Some prefer a riskier option, as the potential rewards are worth the risk to their capital, while others have a much lower risk tolerance and as a result are happy to accept lower potential reward outcomes. It is therefore impossible to construct a single investment portfolio that will be suitable for all clients all the time. So, in order to make sure we have a solution which could be suitable for most investors, we use the diversification approach mentioned above and then also alter the proportions of investment in each of these vehicles depending on a client’s individual approach to risk. An investor with a greater appetite for risk, may therefore have a larger percentage of their portfolio invested in Asia and Japan, while someone who wants to take less risk may have a much larger proportion of their portfolio invested in more stable assets like cash. The bottom line is that investors need to be comfortable with the level of risk they are taking. If they understand how risk works, and have a greater understanding of their own attitude to risk, they will be more likely and, in some cases, more able to remain invested. Worth the Risk In last month’s issue of Wealth & Finance, Martin Vaughan, Senior Partner of Clear Capital Management LLP, talked about how risk was an inescapable fact when it comes to investments. Here, he explains how a better understanding of risk can help to change the way we invest and reduce our exposure to serious risk. Company: Clear Capital Management LLP Contact: Martin Vaughan Contact Email:
[email protected] Address: 35 New Bridge Street, London, EC4V 6BW, UK Phone: 020 3011 5200 Website: www.clearcm.co.uk Clear CM takes an unashamedly sensible approach to the reduction of risk so that we can create investment portfolios that provide clients with solid investment performance alongside a mitigation of risk. We prefer to rely less on hope and luck than on thoughtful, long-term and sustainable investment management. Of course, while we would never condone such an irresponsible action, we may well have bought the odd lottery ticket along the way too!