Trust and risk often go together. “I trust I’m making the right decision to mitigate a risk”. We draw on two Allan Gray articles that discuss how to trust your investment manager and whether your risk perception changed due to the market crisis.
Trust implies a hoped-for outcome: having confidence in my investment manager delivering on my investment goals. Although we know that investment performance does not come in a straight line, how do you retain trust and confidence in your investment manager through inevitable periods of disappointing returns?
What are you trusting your investment manager to do?
Once your personal goals, objectives and risk profile have been established, you need to be clear what you expect from your investment portfolio. This is driven by having the appropriate risk strategy. Review your fund’s mandates and objectives by reading the fund fact sheets, which will detail the fund’s benchmark, time horizon and risk positioning to ensure it is aligned with your risk strategy.
The higher the desired return the higher the required risk, and therefore a longer investment time horizon is necessary to ride out the normal fluctuations along the way.
How do you know you can trust your investment manager to deliver?
Past performance and consistency are an easy evaluation, but they can be misleading if philosophies, processes and people have changed. These are critical for future performance, which we are constantly reviewing at Investonline.
Philosophies are a set of beliefs and principles that guide investor decision making. But they need a robust implementation process driven by the right people in the most suitable organisational structure.
Understanding your risk tolerance
Understanding your risk tolerance is a very personal assessment. Although your perception of risk may have changed during the recent market crash, your tolerance for risk has likely remained the same.
What is Risk?
Many people describe risk differently: At Allan Gray: “investment risk is the probability of permanently losing money.” At Investonline: “what is the probable outcome of an action. e.g. what is the probability of a professional golfer (Tiger Woods) hitting a golf ball onto an island green versus a weekend golfer?” This can be equated to the probability of better investment returns from a professional investment team versus an individual.
Your personal risk tolerance is the amount of risk you are willing to accept in pursuit of your investment goals. It’s an innate personality trait and remains fairly constant, similar to one being an introvert or extrovert. But in times of uncertainty, led by fear and anxiety, one’s risk perception changes. This can lead to a decision made on perceived rather than actual risk, which can be irrational and detrimental to achieving your investment goals.
A study of investors’ risk perceptions before and after the 2008 market crash found that 74% of investors said that the market was riskier after the crisis than before.
So, have investor perceptions changed again as a result of the current pandemic? The graph below shows the switches out of high-equity exposure funds on the Allan Gray platform as investors are de-risking at the height of the crisis.
How do you manage risk misperceptions?
Research your investment and ensure you understand your options when you experience market volatility, which will inevitably come along.
To obtain a realistic view, put your current events and associated discomfort into perspective by looking at your chosen fund’s response to similar events over the long term.
Accept that risk and volatility go hand in hand. To earn a real return, you need to take on some risk which will result in some volatility along the way.