Discretionary Fund Management Risk Profiling

This is a very personal issue. One person’s idea of risk varies greatly from another. Individual risk profiles that identify appropriate investments for a client can be totally unsuitable for another. First and foremost, there is no such thing as Risk Free. Risk gradings are generally proportionate to potential return. Please see pyramid below describing the correlation between products and their risk and reward.  

Therefore, we can identify types of risk into the following groups; these are broadly speaking investment risk and non investment risk.

• Inflation risk - reduces the value of money (non investment risk)
• Volatility risk - change in the face value of investment whilst invested (investment risk)
• Capital risk - loss in value returned to an investor (investment risk).

Cash only has non investment risk - inflation. It has no Volatility risk (it doesn’t fall or rise in value). It has low Capital risk (it is normally secure from total loss).

Low risk is rewarded with low returns, creating inflation risk.

Shares are exposed to greater investment risks but are generally low inflation risk assets.

There are four factors that are perceived to further influence risk when creating a portfolio

• Investment Term - short term investment increases the pressure to return and exaggerates risk from volatility.
• Rate of return - higher returns imply too much risk. Lower returns under achieve the ultimate investment aim.
• Amount invested  - over investment  reduces available cash for other purposes,
• Final value -  lower output and the investment fails! Spending time reviewing risk achieves investment goals by adjusting investment and non investment risk.

It is important to assess and understand risk descriptions.  Appropriate investments can be recommended to individually or collectively match a client’s particular objectives. ‘Benchmarking’ (identifying a suitable reference to compare against) is an important part of risk profiling.