Risk is most commonly equated directly to the volatility of the pricing of the investment. The main reason for that is that price is the only factor that is known with certainty.
Most of the risks for investments in companies selected by fund managers cannot be known precisely. High volatility is inherent in the share price of high growth companies. In working out the possible future value of a company’s shares, the market factors in many variables that are not precisely known, for which the potential effect of a variable on that company is even less precisely known. The market’s weighting of these many factors can change dramatically with changes in market sentiment.
Some highly capable investment managers have developed abilities to identify companies with strong strategic advantages and methods of making enquiries to clarify the variables that are relevant and the effects those variables are likely to have on future growth and profitability, to support their conviction about a company. Sometimes high conviction managers get a call wrong, but persistent long-term outperformance is the most reliable indicator available of the quality of the investment manager’s judgement and ability to translate qualitative strengths into quantitative returns for investors.
Volatility works in two directions, up or down. A low volatility stock is not inherently less risky, particularly if the stock’s low-level volatility is trending long term in a downwards direction. Conversely, a high volatility stock has high uncertainty, but the judgement and detailed research of a skilled investment manager is a significant factor in reducing actual investment risk (defined by actual loss of capital).
When selecting investments for inclusion in a portfolio, each position in the portfolio must be considered carefully for its contribution to optimising the long-term total return. Asset allocation and selection and size of each position in the portfolio must be reviewed regularly and changes made to accommodate changing market and economic conditions.
Article Supplied by Scott Heathwood of https://www.wealthyandwise.com.au
The Tax, Super & Financial Advice One Stop Shop
