What is risk to you?
Well, this is the question I have been asked more over the last twelve months than for a very long time. Largely because the sea change in relative security of assets caught several clients, professionals and commentators by surprise. Risk to me and our house view is that the portfolio must be providing the outcome needed by the client over the time frame agreed. A simple statement, but it is a journey not just a destination- clichéd but true.
My portfolio needs to do ‘what it says on the tin’.
The challenge comes that the ‘what it says’ changes as you have a change of heart, objective or life decides to give you an opportunity, or sadly a challenge to overcome. So we need to take a strategic approach to portfolio construction- we know that the ‘tin’ will be there in 15 years’ time as you retire, but hang on I need to retire early…can the portfolio be reasonably adjusted to provide a sustainable withdrawal? Hang on, I want to buy a Camper Van (this has happened, and will happen again), can the portfolio provide cash to support that, without critical detriment to the portfolio and its objective? We don’t plan portfolios to support immediate withdrawals of income or capital, but we know they happen- so we keep it in the back of our mind.
If you build it well, risk will come, and you’ll weather it well.
So at the risk (see what I did there?) of being a tad technical let’s consider diversifying risk without removing opportunity- knowing that the only constant is that risk isn’t constant- Eh? What?
Well, there’s correlation positive, negative and then uncorrelated (googleable) assets. This has driven the traditional asset allocation where the ‘efficient frontier’ (googleagainable) is a mixture of government debt and company shares- the more money you need to make the higher the percentage of shares you hold in the portfolio. On a ten year view this almost always turns out to be true…1999 to 2009 was a tough decade. However, you can’t completely depend on historic data to control risk- all of us are on the ‘event horizon’ (great movie) of time and the risk today will not be the same as the risks in the future. So, it is good to review the decisions you’ve made and look at how those different assets moved with and against each other, that when netted off gave us the capital return and income cash flow you needed- but that will not do the same again, it might be similar, but it won’t be identical.
Less risk at the bottom, more risk at the top, obviously?
When you balance the historic behaviour of your investments against the future direction of the economy and the services/products that global customers will demand, assuming they can afford to demand them, we need to spread the asset allocation and individual investments as broadly as we can without removing opportunity.
If you considered the possibility that inflation could rise further and hang around longer than generally expected. If you considered that central banks would have to raise rates to combat that inflation then you wouldn’t hold government debt that could fall 20% over the next few months, or hold growth companies that have their high share prices underpinned by low inflation and corresponding low interest rates forever, that would fall in value with the government bonds. Hindsight is easy (and historic, thus can’t be depended upon) but if you considered it then you will have held a lot less of these assets than the consensus of the investment community- you wouldn’t hold none of it…because you might be wrong.
That’s how you avoid those with a lower tolerance for risk, and thus usually a greater exposure to fixed income suffering a greater fall in value than those above them in the ‘risk assessment pyramid’. The more ‘certain’ someone is of their investment position the more likely they are to take inappropriate risk. We continue to control risk between each asset class, within each asset class we apply our themes, but then the individual holdings are as uncorrelated as possible.
This gives you the opportunity to be ‘lucky’, when you have a tough time (like the last twelve months) your portfolio will be more durable, often in ways you didn’t plan or expect.
But what was risk free?
Well, that depends how you define ‘Risk Free’, is cash risk free? Pulling a white fiver (showing my age, although I have never seen one) out of the back of your grandparent’s sofa to pay for a week’s shop isn’t risk free, inflation is here to stay for a while. So, keeping cash for immediate/short term needs is sensible but anything beyond that needs to be invested. I much prefer the statement ‘Nothing is risk free’- but then life is a risk.
Total return, capital and income-more likely to get paid.
Looking forward, with higher interest rates, the income yield on assets feels the pressure to rise, so median risk portfolios will be targeting an ongoing income of 3%, with a similar average capital return over a five-year period. If you diversify the assets you hold and thus the sources of your return, you are more likely to get paid.
Consumer duty supports our view, in our opinion.
Consumer duty looks like a positive effort to put clients at the centre of things by the FCA- that should be as it is now-it is early days and the interpretation of the new environment (plus ca change) will be debated over the coming months and years. I found the most attractive concept the challenge raised by the FCA- would you recommend the service you provide to yourself and your own family. Happy to say that we’re invested alongside you, as is our family.
As always, any comments let us know- Keith
Important Information
This article is for information only and does not constitute advice or recommendation and you should not make any investment decisions based on it. The views and opinions of this article are those of Casterbridge at the time of writing and may change without notice. Any opinions should not be viewed as indicating any guarantee of return from investments managed by Casterbridge nor as advice of any nature. It is important to remember that past performance and the value of an investment, and any income from it, may go down as well as up and the investor may not get back the original amount invested.
