Investors and financial advisors should revisit what they mean by risk because they could miss out on long term profits.
Most investors consider volatility in the markets a risk, but for one man, investing in volatile assets is sometimes distressing, but the returns make the price worth paying.
Greg Davies, of Barclays Bank, argues volatile assets are not always a risk in the hunt for profits.
Most investment firms use a similar methodology risk assessing an investment, he explains, called standard deviation.
He says that a portfolio harnessing low yielding assets in the search for profits is a risk in the long term, since these will often have low or even negative, returns.
Bad outcomes
In contrast, short term volatility is the price paid for higher returns on assets.
“When standard deviation is minimised, we end up filtering out assets that could end up on a good path to good outcomes as well as those that will have bad outcomes,” he said.
He also pointed out that the biggest issue with standard deviation is that the analysis does not consider whether an outcome is good or bad, but simply penalises an asset that has variation.
However, Greg says this is akin to telling an investor that an asset that could potentially return more than 5% a year is excluded from a portfolio because standard deviation will view this as an undesirable outcome.
Investors need to understand that by including higher risk or volatile assets in their portfolios, they are actually decreasing rather than increasing risk.
He adds: “What’s needed is a measure that doesn’t throw out assets that have variability in their outcomes.”
Behavioural risk
At Barclays they call theirs ‘behavioural risk’ because the formula also looks at how investors should consider risk and the trade-offs necessary to bring profits.
The result is, says Greg: “The ability to build a portfolio by focussing on what matters to the investor, which is the profit over the long term and not the volatility along the way.”
He says wealth is boosted because an investor will weed out bad outcomes in favour of good ones, which is what traditional portfolio measurement filters tend not to do.
Essentially, he says that volatile investments will deliver reward even if the journey is more dramatic than usual.
