Assessing and managing portfolio risks

[Snoopy]

We have recently had a situation where ‘risk’ has been the topic of discussion. Sadly that was shut down by optimists who focused only on likelihood which they assessed as ‘unlikely’, and therefore chose to ignore consequence.

Imho portfolio management must focus on risks as much as rewards.

In order to do so risks have three elements: 1. what could possibly go wrong. 2. What is the likelihood of the risk eventuating. 3. What is the consequence of the risk eventuating.

Good risk assessment cannot ignore any of those three elements. The tendency however is for optimists to wade in and debunk the risks by arguing that the likelihood is so low, that consideration of the risk in itself, is therefore irrelevant, as the risk is inconsequential.

I have a significant proportion of my investments in the 'gentailer' domain. Over the last few years there has been discussion on how the gentailers would be affected if Tiwai point pulled the plug, and what might happen should the green party form part of a government, and regulate returns on power generation assets based on historical construction costs of power stations. IOW the power sector has had, and continues to have, significant risk for investors.

One consequence of that risk is that the share prices of gentailers have at times been lower than they would otherwise have been. Consequently they have at times looked to me 'great value' and I have been buying. If Tiwai did pull the plug, I have assessed that these power sector investments might take ten years to recover. While unwelcome, I would be prepared to wait for ten years should the worst happen. So I think that I have assessed and taken account of what I would do should the worst power sector risk consequences happen.

The key lesson here is that if you see a risk, make sure your purchase price of any investment in that sector is discounted to reflect:

1/ both the likelihood AND
2/ the consequence

of that risk.

Lastly, because even industry insiders do not have a handle on the consequences of some market factors going against them, don't put all your investment eggs in one industry sector, no matter how well you think you know it.

SNOOPY