Assessing and managing portfolio risks

[Baa_Baa]

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.

What these optimists do not put forward in their argument, typically, is what the consequence is, that is somehow inconsequential, in light of their argument that the risk is of low likelihood.

Good debate on investments imho should always consider the risks of investment.

This cannot be achieved without good risk assessment practices. Smart investors should not be swayed by commentary from vested interests (typically holders), that refuse to examine consequence, and seek only to debunk likelihood.

If we don’t assess the risks of investment, we cannot manage those risks, except retrospectively. Usually that’s too late to do anything materially significant, except get out and probably in a panic.

There are better approaches for the more reasoned and informed, especially those who look at risks and how they will respond, in advance of them potentially occurring. For example, avoid the risk, ameliorate the risk, treat the risk, avoid the risk, manage the risk.

None of this happens if one does not choose to apply simple risk assessment techniques, of which identifying potential risks is one, assessing likelihood is another, and importantly considering the consequence, which is key.

If one gave a metric to each of the measures of likelihood and consequence of identified risks, as is good practice in risk assessment and management, then they are better informed to determined their ‘treatments’ or responses, to those risks, should they arise.

If this thread gets some legs, I'll show you how to identify risks and put measures against likelihood and consequence, and assess them, so that you can get some perspective on what constitutes real or perceived risks and whether or not you should be concerned about them.

If risks do eventuate, then they become issues, and issues are managed differently from risks, but the informed are better prepared than the uninformed to mange those issues.

BAA

[BIRMANBOY]

BB...surely anyone who invests in share markets has to be an optimist? There are so many things that could go wrong that cautious people are usually reluctant to '"chance their luck". So focussing on risks or giving risks equal attention is likely to be an unpopular strategy. Good to understand and have a method of dealing with it however and good on you for attempting to be proactive about it. The problem for me, and I consider myself a cautious investor, is that my experience has led me to believe that focussing on risks has led to more problems than the contrary option. Perfect example is someone, who shall remain nameless, who has been sold up on all their investments for over a year because they were convinced the S**T was about to hit the fan. So this type of investor becomes paralyzed by fear...of the unknown..of the risks..of their ability to manage and handle the risks. I agree that investors should be AWARE of risks but to a much lesser amount than yourself. Maybe its one of those individual things where everybody finds their own comfort level.
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.

What these optimists do not put forward in their argument, typically, is what the consequence is, that is somehow inconsequential, in light of their argument that the risk is of low likelihood.

Good debate on investments imho should always consider the risks of investment.

This cannot be achieved without good risk assessment practices. Smart investors should not be swayed by commentary from vested interests (typically holders), that refuse to examine consequence, and seek only to debunk likelihood.

If we don’t assess the risks of investment, we cannot manage those risks, except retrospectively. Usually that’s too late to do anything materially significant, except get out and probably in a panic.

There are better approaches for the more reasoned and informed, especially those who look at risks and how they will respond, in advance of them potentially occurring. For example, avoid the risk, ameliorate the risk, treat the risk, avoid the risk, manage the risk.

None of this happens if one does not choose to apply simple risk assessment techniques, of which identifying potential risks is one, assessing likelihood is another, and importantly considering the consequence, which is key.

If one gave a metric to each of the measures of likelihood and consequence of identified risks, as is good practice in risk assessment and management, then they are better informed to determined their ‘treatments’ or responses, to those risks, should they arise.

If this thread gets some legs, I'll show you how to identify risks and put measures against likelihood and consequence, and assess them, so that you can get some perspective on what constitutes real or perceived risks and whether or not you should be concerned about them.

If risks do eventuate, then they become issues, and issues are managed differently from risks, but the informed are better prepared than the uninformed to mange those issues.

BAA

[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

[Snow Leopard]

http://www.zerohedge.com/sites/default/files/images/user5/imageroot/black%20swan%20teaser%202.jpg

1/ Black Swan

http://i.dailymail.co.uk/i/pix/2014/10/17/1413503289588_Image_galleryImage_AP5AXP_Welsh_Blac k_sheep_.JPG

2/ Black Sheep

https://aos.iacpublishinglabs.com/question/aq/700px-394px/scientific-name-black-panther_38c7a28abbbb4ffa.jpg?domain=cx.aos.ask.com

3/ Black Tiger


With risk comes reward or ruin.
Plan for one and hope for the other.
Or vice versa.

Remember that there are known knowns,
and known unknowns,
and, of course, unknown unknowns.

Que sera sera,
[whatever will be will be]
Off for a black coffee,
hopefully.


Best Wishes
Paper Tiger

[Joshuatree]

All i can addis

Never buy a share 15 mins after imbibing a coffee, drink water and wait for the irrational exuberance to subside.

Double shot latte is as far as I've got. My aim to get to an Americano(a short black) will be enacted on when I'm in the coffin; it may bring me back briefly (a short black moment).

[artemis]

..... 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.....

That particular risk has diminished with the Greens announcement they are dropping the policy. Going for getting the taxpayer to subsidise power bills instead. Always simpler to give away Other People's Money rather take on a large, complex and risky venture.

[Snoopy]

BB...surely anyone who invests in share markets has to be an optimist? There are so many things that could go wrong that cautious people are usually reluctant to '"chance their luck". So focussing on risks or giving risks equal attention is likely to be an unpopular strategy.


I don't think anyone suggested that risks be given 'equal attention' to whatever positive outlook an investor may have. If I read Baa Baa correctly, giving risks 'appropriate attention' might be a more accurate guidance statement.



The problem for me, and I consider myself a cautious investor, is that my experience has led me to believe that focussing on risks has led to more problems than the contrary option. Perfect example is someone, who shall remain nameless, who has been sold up on all their investments for over a year because they were convinced the S**T was about to hit the fan. So this type of investor becomes paralyzed by fear...of the unknown..of the risks..of their ability to manage and handle the risks. I agree that investors should be AWARE of risks but to a much lesser amount than yourself. Maybe its one of those individual things where everybody finds their own comfort level.

Selling up all your investments is the ultimate expression of 'timing the market'. I am not sure that anyone appointing themselves 'great guru of all investments' and then making an 'all in' or 'all out' decision is a portfolio risk strategy!

I think Birmanboy that your own strategy of looking for companies that offer you a decent yield is in itself a kind of 'derisked' investment strategy. Because with that kind of investment philosophy, all you are largely banking on is a business keeping doing what it has already been proven to be able to do in the past. That seems to me in general to be a fairly low risk assumption. IOW you have covered off your own risk to a large extent by mostly going for high yielding shares.

SNOOPY

[kiora]

Uncle Bobs salient advice. Ok if you wish to have an average retirement savings :)
http://www.noted.co.nz/money/investment/sir-bob-jones-on-how-we-get-it-wrong-with-saving/?utm_source=outbrain&utm_medium=cpc

[777]

He looked quite a nice guy in that photo of 1966. I wonder when he turned.

[kiora]

He looked quite a nice guy in that photo of 1966. I wonder when he turned.

When he publically listed ;)

[kiora]

Just came across this so thought I'd post
https://medium.com/stockswipe-trade-ideas/90-90-90-trading-rule-85da21808652

[bullfrog]

Interesting read BB. Method of failure, probability of failure, consequences of failure. All for new ideas, but ask yourself these questions, then add on will this get me sacked, and you have group management 101.
i took a completely different tack to snoopy, I did have shares in gentailers, but then suddenly realised I'm living in a land of earthquakes, what on earth am I doing investing in power companies??? First chch, then Blenheim, slow slip in east half of north island.... (yes, I know we're talking geological time, but still, all that infrastructure).
These forums contain a lot of positive bias, bring it on BB, I'm interested.

[Grunter]

First time back on these forums for about 18 months - good to check in on the topic of risk.

Risk management is what I do for a crumb - specifically the financial impacts rather than physical, so I love to delve into this area.

I would argue that one element of risk is not an element "method of failure" as it is possible in an investment portfolio to diversify exposure to method of failure to the point where how something fails does not matter, it's only the likelihood and degree of which it fails that matters.

This is mathematically expressed through the volatility of returns (the dispersion of returns from its mean) and the probability that the returns of a portfolio will not exceed a certain negative value so as to cause portfolio ruin or some predetermined tolerance.

Once those concepts are understood, you then view your investments through a completely different lens - how are assets in my portfolio correlated? (Why do retirement village shares seem to move together?) therefore how much of an asset should I buy to reduce the effect of a downward price movement on my portfolio - should I buy another asset as well that is likely not to move down or even up in that scenario?

Taken even further, you begin to ask the question - does the asset itself actually matter, or only the statistical properties of the asset matter? if one company goes bust, does my portfolio construction mitigate this possibility and does it have an overall effect on the performance of my portfolio?

Proper portfolio construction can therefore eliminate the method of failure element - leaving the probability of failure and extent of failure as the remaining elements.