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The Risk Assessment Spectrum: A Critical Tool for Investors Pt1

Tue, 20 Nov 2012 14:25:19 GMT

To what degree do you consider risk when making investment allocations?

Identifying portfolio risk adequately and efficiently is a common talking point among investors.  Investors often get hung-up over the complexity of portfolio risk management, by overestimating the resources it requires and the costs involved. In this series of blog posts, we will explore what we define as the ‘risk spectrum’ by focusing on portfolio risk management in order to help you better understand the different analytics available for use within your risk management processes. 

Risk can mean a host of different things to different investors.  Investors often think of risk as being volatility which often leads to thoughts of diversification as a way to try to temper the volatility in a portfolio. To diversify your portfolio, you might look at additional statistics such as alpha, beta and correlation, all of which we will discuss.

However, there are other types of risk that are often overlooked. Although you may have made investments in different managers, have you mitigated your exposure to certain markets or are there overlaps?  Has your model assumed a normal distribution when in fact you may have more of a fat-tailed situation? Can you gain access to your funds when you need them or do you have a hidden risk caused by liquidity restrictions?

In addition to the depth of the analysis that you’d like to perform, investors need to consider the types of resources that they have available. What are the cost factors for implementing these systems?  Once the systems are in place and the results are in hand, can you interpret the output and factor it into your decision making process?  The complexities found within today’s investment options can make answering all of these questions quite a challenge – leading you to ask yourself, where do I fit on the risk assessment spectrum? Am I on the left hand side, the middle, or the right?


PerTrac Risk Assessment Spectrum


The risk assessment spectrum provides a framework for you to understand a sensible approach to managing your portfolio risk.  It’s broken down into three ‘buckets’ to better identify each level of risk assessment, taking into account the other factors to consider; resources, sophistication and costs.  It’s important to remember that no matter where you fall on the spectrum; there are tools that you can use to assess risk in your portfolio.  In most cases these tools may well allow you to do more analysis than you first thought. 

Check back soon for our analysis of each of the risk buckets.

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