The Risk-Return Trade Off

Feroze Azeez, Deputy CEO, Anand Rathi Wealth Services Limited

Calculating risk is another myth in our industry. Everybody loves to say that I don’t like to take risk but risk has not been measured, only return has been measured. If you ask an investor how do you measure your risk? He will say I know I made 13% last year but won’t know the risk that he has taken.

There are ways to measure risk, Standard Deviation is one of them. It sounds complicated but it is very simple. Standard deviation is a measurement of risk. The benchmark that one can compare to is Nifty. Now, Nifty’s standard deviation is 12, so if your portfolio’s standard deviation is less than 12, then you are on the right track. If the standard deviation of your portfolio is 20, then it means risk management has not been done.

So, it should be that you measure your risk, which can be done on an excel as it has an in-built formula to measure risk.

The other way to measure risk is to ensure that you are prepared for the worst, for example such as another occurrence like the 2008 carnage. At such times, what happens to the client’s capital? This can be measured by calculating the Value At Risk. Large treasuries do this on a daily basis. So, if you are prepared to lose an ‘x’ amount of money, on the worst day, you should not lose more than that ‘x’ amount. These are the two measures of risk.

Balancing risk and return is crucial. First of all, return should not be on a component, it should be on your overall investment. This is where clients get a little distorted. If they see one stock doing well, they fail to realise that it is not going to take them places. That stock will give you money to party, but not build your wealth. You can create wealth when all the constituents of your investments do well. Your overall investment should give you realistic return, with one or two components giving you enhanced returns. So, aiming for a 15% return is achievable with risks such that if the market is 20% down, the client’s capital remains untouched within a three year period. So, risk management must be done while designing a client’s strategy.

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