Risk, But Not as Many Know It

A basic and undeniable fact: Risks exist in many forms.

One of the basic fallacies of modern portfolio theory is the belief that risk can be defined and measured by variability in the price of securities. However, this is only a partial measure of total risk.

I would define risk as the exposure to the possibility of loss.

A taxonomy of risk was outlined by former US Defence Secretary, Donald Rumsfeld, in a press conference in 2002: ‘Reports that say that something hasn’t happened are always interesting to me, because as we know, there are known knowns; there are things we know we know. We also know there are known unknowns; that is to say we know there are some things we do not know. But there are also unknown unknowns – the ones we don’t know we don’t know.’

To some, this may seem an unlikely source for insights about market risk as well as general risks. We still do not have precise quantitative knowledge of the feedback between financial and real variables.

Known risks are those that are defined by current knowledge. They can be modelled, estimated and the parameters calibrated. Unknown risks are subject to statistical determination based upon what is already known, but the parameters cannot be calibrated. The unknowable risks cannot be known and cannot be modelled.

We humans seem to attach greater significance to specific events that have already occurred when we try to anticipate the future. That type of mental gymnastic is the reason that something that has never occurred gets a low probability when trying to predict or model risk.

Managing risks really means reducing the cost and likelihood of potential perils for a price. Our own approach incorporates behavioural, liquidity and non-linear dynamic factors.

Introduction to AssetAllocation Plus - The Blog Begins

Asset allocation is the first step in any investment process. It is a vital element as it sets the stage for any portfolio's return and risk profile.

Academic studies have shown that more than 90% of variability in investment performance can be attributed to asset allocation.  Decisions concerning asset mix have a greater impact on a portfolio's overall investment results that individual security selection or market timing.

Multi-asset, multi-market and multi-style can be combined to produce portfolios that can be constructed to be strategically actively managed within client-determined risk ranges.

In this blog I will explore a wide range of traditional (stocks, bond and cash instruments) and alternative (hedge funds, private equity, real estate, commodities, currencies, timberland, etc) asset classes, markets, styles and strategies.

I am open and flexible regarding the mix of components that can be used as it depends on client investment objectives, risk tolerances, income requirements and liquidity needs.  I believe that getting market exposure through cheap and efficient building blocks such as ETFs, index funds and futures are valuable tools in the portfolio construction and risk management process, especially when combined with active alpha generators.

Keeping up with economic, market and political factors are important in trying to anticipate what could happen and by developing strategies that reflect those views.  We certainly do have our opinions, views and strategies.

I hope you enjoy reading and interacting with this blog and welcome your feedback.