Risk on… risk off… or risk right?
Advisors and investors alike can certainly be forgiven for feeling harried as they gear up for the next cycle of quarterly portfolio reviews. After nearly five years of capital markets whipsawing between “Risk On” and “Risk Off” many advisors are left asking themselves questions like “Am I doing the right thing for my clients? How much risk is right?” For many individual investors, the extremely volatile markets have felt like they’re at the mercy of a heartless, all-powerful being that keeps manically flipping a Risk switch On and Off without warning.
This has left many investors in a state of disengagement and mistrust. For them, withdrawing from the market or, in contrast, trying to anticipate market movements and shifting parts of their portfolio in and out of the markets as news becomes available, have become coping mechanisms. In our view, this new environment will require advisors and their clients who want to improve portfolio outcomes to manage risk more actively in order to take advantage of new opportunities the rapidly changing capital markets offer.
Of course, times of crisis and rapid change elevate risk. A world in which a country (a.k.a. Greece) that represents less than 0.5% of global GDP1 dictates whether global markets are up or down on a daily basis for months is a more integrated and riskier world. Clients need help assessing and actively managing these risks.
We believe the old adage “every cloud has a silver lining” holds true even in this situation. The changed environment certainly has produced greater opportunities. For example, new ways to benchmark performance, new ideas about capital market expectations, new ways to manage risk in portfolio construction. Adept active managers can potentially uncover value that rash or less experienced investors have discounted.
In a world where markets swing violently – sometimes even within just a few hours – many investors don’t have the luxury of time. They need help executing new insights promptly.
Translating this for clients
Acknowledging their wariness of the markets, you can help your clients adapt thoughtfully to the current environmentby using an approach we at Russell call “Risk Right.” It has two components:
- Diversification. Although diversification does not protect against loss, it may be a good option for those who can’t predict the future and hence don’t know how certain investments may move.
- Helping clients determine the degree of risk they need in order to achieve their future financial security. At times this approach to “budgeting” risk in a portfolio may mean adapting a client’s investments to their goal (for example, coaxing the investor back into the markets or rebalancing); other times it may necessitate adjusting the goal itself. Most of all, though, this approach provides a guide for allocating assets based on math rather than mood.
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1Greece gross domestic product data is for 2011. Source: International Monetary Fund, World Economic Outlook Database, April 2012