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How to manage your investment portfolio risks

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1 year ago

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FP columnist Martin Pelletier is an avid mountain biker and has learned the hard way how to adjust for risk. Photo by Gavin Young/Postmedia

Being an avid downhill mountain biker and skier, I learned the benefits of defining and assessing risk the hard way rather quickly, but many ignore risk when investing or get their assessment wrong when trying to understand what it truly entails.

Risk is the possibility of something unpleasant or unwelcoming happening weighed against the reward being offered by certain activity. In the case of investing, it is the probability of locking in a permanent loss, while in adventure sports, it’s the chance of permanent injury.

It’s important for investors to realize that the greater the variability of your returns, the greater the chance of making a mistake because of emotions entering the decision-making process. Think of it this way: the steeper the mountain, the greater the speed involved, and the more turns and objects you need to handle, all of which creates a higher likelihood of crashing.

Measuring the standard deviation of your portfolio is a good initial indicator of how steep the risk curve is as well as the overall level of risk being taken onboard.

Ideally, you want a portfolio manager who will create what is called a positive asymmetrical return profile, which refers to a strategy that aims to provide higher potential returns than potential losses.

This essentially creates a favourable imbalance between profit and loss, or positive and negative returns. As a result, there is a safety net in the event of a crash that minimizes the chance of your portfolio undergoing an injury that prevents it from achieving its overall objective.

Last year was an excellent chance to evaluate your portfolio because if it fully tracked a passive benchmark during a negative event, such as high inflation and the corresponding rapid rise in interest rates, there was no such safety net and, therefore, little to no risk management being offered.

In such a case, you are simply better off owning the market passively and doing it yourself rather than paying fees to have someone steer your portfolio.

This is because stock market returns by default are asymmetric given they have what are called fat tails, meaning there can be huge gains or losses at both ends of a distribution curve. Fat-tail events are rare, at more than three standard deviations from the mean, but they can wreak havoc on a portfolio when they happen. Worse, you react by trying to time the market, thereby locking in those losses.

This is why it is important to employ tail-risk hedging within your investment portfolio. As risk managers, we deploy such strategies via structured notes that have embedded downside barriers, as well as tactical asset allocation.

For example, having long-dated U.S. Treasuries provided excellent downside protection during the March 2020 COVID-19 meltdown. More recently, we were able to provide flat performance last year in our balanced strategy, while most 60/40 portfolios fell by 10 to 15 per cent, by greatly reducing our duration exposure within both our bond and equity positions, as well as by adding a slice of inflation protection via a 10-to-15-per-cent weighting to energy.

Looking ahead, not surprisingly, those who fully participated in last year’s correction are now advising people to double down and take on extra-long duration to try to recoup those paper losses. This is a classic example of what we call loss aversion in our business. It could possibly work out, but it nonetheless adds more risk to your portfolio.

Making bets in an attempt to capture the right side of a low-probability, fat-tail event because you participated on the wrong side of a negative event is not something we’re interested in doing. We much prefer an approach that reduces the variability of your portfolio and maximizes the probability of achieving your target return independent of what everyone else is doing.

Or, as Benjamin Graham famously said: “The essence of investment management is the management of risks, not the management of returns.”

Martin Pelletier, CFA, is a senior portfolio manager at Wellington-Altus Private Counsel Inc, operating as TriVest Wealth Counsel, a private client and institutional investment firm specializing in discretionary risk-managed portfolios, investment audit/oversight and advanced tax, estate and wealth planning.

 

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S&P/TSX composite up more than 100 points, U.S. stock markets mixed

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1 day ago

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October 16, 2024

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TORONTO – Canada’s main stock index was up more than 100 points in late-morning trading, helped by strength in base metal and utility stocks, while U.S. stock markets were mixed.

The S&P/TSX composite index was up 103.40 points at 24,542.48.

In New York, the Dow Jones industrial average was up 192.31 points at 42,932.73. The S&P 500 index was up 7.14 points at 5,822.40, while the Nasdaq composite was down 9.03 points at 18,306.56.

The Canadian dollar traded for 72.61 cents US compared with 72.44 cents US on Tuesday.

The November crude oil contract was down 71 cents at US$69.87 per barrel and the November natural gas contract was down eight cents at US$2.42 per mmBTU.

The December gold contract was up US$7.20 at US$2,686.10 an ounce and the December copper contract was up a penny at US$4.35 a pound.

This report by The Canadian Press was first published Oct. 16, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

The Canadian Press. All rights reserved.

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S&P/TSX up more than 200 points, U.S. markets also higher

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6 days ago

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October 11, 2024

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TORONTO – Canada’s main stock index was up more than 200 points in late-morning trading, while U.S. stock markets were also headed higher.

The S&P/TSX composite index was up 205.86 points at 24,508.12.

In New York, the Dow Jones industrial average was up 336.62 points at 42,790.74. The S&P 500 index was up 34.19 points at 5,814.24, while the Nasdaq composite was up 60.27 points at 18.342.32.

The Canadian dollar traded for 72.61 cents US compared with 72.71 cents US on Thursday.

The November crude oil contract was down 15 cents at US$75.70 per barrel and the November natural gas contract was down two cents at US$2.65 per mmBTU.

The December gold contract was down US$29.60 at US$2,668.90 an ounce and the December copper contract was up four cents at US$4.47 a pound.

This report by The Canadian Press was first published Oct. 11, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

The Canadian Press. All rights reserved.

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S&P/TSX composite little changed in late-morning trading, U.S. stock markets down

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1 week ago

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October 10, 2024

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TORONTO – Canada’s main stock index was little changed in late-morning trading as the financial sector fell, but energy and base metal stocks moved higher.

The S&P/TSX composite index was up 0.05 of a point at 24,224.95.

In New York, the Dow Jones industrial average was down 94.31 points at 42,417.69. The S&P 500 index was down 10.91 points at 5,781.13, while the Nasdaq composite was down 29.59 points at 18,262.03.

The Canadian dollar traded for 72.71 cents US compared with 73.05 cents US on Wednesday.

The November crude oil contract was up US$1.69 at US$74.93 per barrel and the November natural gas contract was up a penny at US$2.67 per mmBTU.

The December gold contract was up US$14.70 at US$2,640.70 an ounce and the December copper contract was up two cents at US$4.42 a pound.

This report by The Canadian Press was first published Oct. 10, 2024.

Companies in this story: (TSX:GSPTSE, TSX:CADUSD)

The Canadian Press. All rights reserved.

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