What is Risk?
Risk is hard to define and even harder to measure. Because you can’t manage what you can’t measure, you cannot manage risk. You can only attempt to weed it out. Various selection processes and trading tactics can help reduce many types of risk.
What is a useful definition of risk as applied to mutual funds? It is the probability of or chance of the loss of capital. It is this probability and its potential causes that create so much trouble. People disagree on what to measure and further can’t agree on how to measure it. Do we use standard deviation, semi-variance, maximum drawdown, value at risk, downside deviation or estimated tail loss? Do any of these truly explain risk or account for it completely?
This places investors in jeopardy of loss of capital, because they’re placed into positions of risk they do not understand. Without understanding there's no plausible means of managing money effectively. This means there's always a chance of loss of capital, no matter how well constructed a portfolio may seem, or how well managed it may be. This couldn't be more true during bear markets, and good reason to validate your portfolio model assumptions, often.
During bull markets, perhaps it means the relative performance is less than the industry average, implying a chance of not earning as high a return as one should for taking on certain levels of "risk". This must be why so many people refer to 'risk-adjusted' returns. We could also compare relative returns against the 90-day T-Bill rate (the 'risk free' rate) to benchmark performance and risk.
Ask your fund and money managers how they ameliorate problems associated with risk and how they will protect your capital from loss.
What is a useful definition of risk as applied to mutual funds? It is the probability of or chance of the loss of capital. It is this probability and its potential causes that create so much trouble. People disagree on what to measure and further can’t agree on how to measure it. Do we use standard deviation, semi-variance, maximum drawdown, value at risk, downside deviation or estimated tail loss? Do any of these truly explain risk or account for it completely?
This places investors in jeopardy of loss of capital, because they’re placed into positions of risk they do not understand. Without understanding there's no plausible means of managing money effectively. This means there's always a chance of loss of capital, no matter how well constructed a portfolio may seem, or how well managed it may be. This couldn't be more true during bear markets, and good reason to validate your portfolio model assumptions, often.
During bull markets, perhaps it means the relative performance is less than the industry average, implying a chance of not earning as high a return as one should for taking on certain levels of "risk". This must be why so many people refer to 'risk-adjusted' returns. We could also compare relative returns against the 90-day T-Bill rate (the 'risk free' rate) to benchmark performance and risk.
Ask your fund and money managers how they ameliorate problems associated with risk and how they will protect your capital from loss.
Comments