Chase de Vere guide to
Investment Risk

We never underestimate the importance of your investment. So we never underestimate risk.

At the heart of any successful investment plan is the integration and management of risk. It is therefore an essential aspect of the Chase de Vere advice process that you understand what risk is and what place it has in your investment strategy. This Guide will provide such an overview as well as demonstrating how an investment strategy recognises the level of risk that you as an individual are willing and able to take.
Your Chase de Vere adviser will discuss investment and other risks with you so that you will be able to agree on an appropriate, risk-adjusted investment path that is right for you and your circumstances.

What is Investment Risk?

You will not be able to plan financially without understanding investment risk. When people hear ‘risk’ in association with investing, the first thought tends to be of loss of capital. Risk however goes much further than that and covers the full extent to which investments make or lose money.
Risk is also about considering the future – the uncertainty and unpredictability that exists when it comes to understanding what the final position will be when the time comes to cash in an investment. So, while capital risk is an aspect, there are many other factors such as inflation and interest rates which will have an effect on your potential returns. How much these factors impact will depend upon how you invest, which is determined by several elements including your own attitude towards risk.
If you understand what risk is really all about in respect of investing – and identify your own attitude to risk - then you will be in a better place to create a portfolio that includes risk at a level that you are comfortable with.

What types of risk are there?

There are numerous risks which may impact your investment portfolio to a greater or lesser degree and it is important that you have an awareness of these. By doing so, you will be able to better define your attitude to risk. This will be used as part of our process in creating the investment strategy that meets your objectives.

Inflation risk

The risk that the value of your investment in real terms - its purchasing power - will be eroded because of rising costs. With their generally low rates of return cash deposits are particularly susceptible to inflation risk. The best way to counter this risk is to hold your money in investments which are likely to beat the rate of inflation.

Capital risk

The risk that you will not get back some or all of the money – your capital – that you have invested. Every type of investment carries a risk to your capital, albeit to a greater or lesser degree.

Interest rate risk

The risk that a change in interest rates will affect the value of your investment. This is more of a risk for cash deposits and bonds than company shares.

Shortfall risk

The risk that your investment fails to achieve your expected or required returns. An example of how this may particularly affect you is where the investment has been made to cover a known future cost, such as the payment of school fees for example.

Business risk

The risk that a company in which you are invested generates less profit than expected or actually loses money, and that the shares in that company are devalued as a result. A common way to mitigate this risk is to invest across a range of different companies, for example through an investment fund.

Liquidity risk

The risk that you will not be able to sell your investment at the time of your choosing or in the amounts required because of limited demand. A good example would be the potential difficulty of selling a property during a crash in the housing market.

Credit risk

The risk that a bond issuer is unable to pay the expected interest rate payments. Typically, the higher the credit risk, the higher the interest rate on the bond. An example of this during the credit crisis was Northern Rock. It was unable to repay depositors as those that owed the bank itself were unable to return monies they had been lent.

Taxation risk

The risk that an investment sold with particular tax benefits does not retain those tax benefits for its full term. An example is that of an ISA which is currently exempt from income and capital gains tax but there is no guarantee that this will remain the case forever.

Currency risk

The risk arising from fluctuations in the value of the foreign currency in which your investment is denominated versus your home currency. Its impact could be such that a fall in the exchange rates would reduce the returns achievable by your investment.

Market or volatility risk

The risk that the future performance of your investment will be unpredictable, or volatile. The greater this volatility, the greater the potential for exaggerated returns or losses especially over the short-term. Cash is seen as a more stable investment whereas shares are by comparison more at risk to greater changes in value, which may be positive or negative.

Investment manager risk

The risk associated with the management of an investment. This risk recognises that there is a huge variation in the performance of individual investment managers, and that it is possible to expose your money to a bad manager.

Country risk

The risk associated with investing abroad, particularly in countries that may be open to certain ‘instabilities’. This can include such things as exchange rate fluctuations and political upheaval which, for example, may result in the freezing of financial assets. So, while a West European democracy like France may carry a low risk, a country suffering from civil war would not be a secure investment opportunity.

Concentration risk

The risk associated by having ‘all your eggs in one basket’. If you are heavily invested in one asset type, then you are more exposed to any impacts that are experienced by that investment. For example, if you invested in shares across a mix of different companies, then a fall in value of one share allocation won’t affect your other investments.

What are the different types of investment?

How the different risk elements impact on your strategy depends upon the mix of investment types (or asset classes) that are available to invest in. At Chase de Vere, we consider four main asset classes:
Cash or money held on deposit – typically held in a bank or building society account providing a stable and low risk return.
Fixed Interest/Bonds – includes government and corporate bonds. Works in a similar way to a loan and returns a fixed interest for a given period of time.
Equities – shares of ownership in a company. Tends to be the most volatile asset class but can also generate the greatest returns.
Commercial Property – investment in property. Is a less liquid asset than the other classes. Generally held for a longer term objective.
Each asset class offers different levels of risk and return as illustrated by the graph opposite, top.

As a general rule, the riskier an asset class the higher the potential for long-term growth, but also the higher the potential for short-term loss. This brings us back to market or volatility risk as explained earlier – and what potential there is for an asset class to fluctuate in value. Each asset class has a different level of volatility and the more volatile an asset is, the greater the risk of loss; see graph opposite, bottom. This illustrates how high-returning assets, such as equities, deliver the highest average returns, but they also have a much wider range between their peaks and troughs than bonds or cash - which reflects their relative volatility – and highlights the traditional relationship between risk and return. There are ways of mitigating the potential risk of volatile asset classes – for example pooled investments where your money is spread across many different companies so if one doesn’t perform well, there are others in the mix which will cushion the impact. This is an aspect of risk management and includes the positive benefit of a strategy known as diversification which we will now look at in more detail.

How can you manage risk?

Investing in a single asset class may not be the most appropriate solution for your circumstances or to meet your objectives. On one hand you might invest wholly in cash and face the prospect of losing money in real terms because your capital growth is being outpaced by inflation; on the other hand, by investing in high-risk company shares you might face dramatic financial loss. The answer is to spread your capital between and within the different asset classes – to diversify.
The amount that you should invest in any of the different asset classes will be determined by the investment returns required to meet your financial objective and the level of investment risk that you are prepared and able to take. So, those able to take on a higher degree of risk for the potential of greater reward will have a higher proportion of equities in their portfolio. Those with a lower risk tolerance will have more weighting toward cash and fixed interest assets.
The notion of correlation will also play a part in building a diverse portfolio. Simply put, this is a consideration of how asset types behave relative to one another under the same market conditions. A truly diverse portfolio will include assets that behave differently in certain conditions, so if the value of one investment drops, then the value of another may rise.

How do you maintain an investment portfolio?

Let us assume that the right investment strategy for you is a portfolio comprising 60% equities and 40% in cash, fixed interest or bonds. Your Chase de Vere adviser then puts the portfolio in place. That’s really just the start of the story. Over time, your original asset mix proportion will vary due to the differing performances of the classes invested in. As one asset’s returns increase and another’s reduces then the holdings you have in each asset will change in proportion and correspondingly the risk profile of your investment will change. For example, the original 60% of your money that was invested in equities might have increased to 73%, which increases the risk profile of your portfolio. We refer to this movement as ‘portfolio drift’.

To combat the effect of portfolio drift, your Chase de Vere adviser will provide a regular review service, part of which will include a rebalancing exercise. Rebalancing means ensuring that the mix of assets you are invested in at the time of a review continues to be in line with your risk management strategy. The chart on the right illustrates this rebalancing exercise.
Rebalancing should not be done on a whim and planning appropriate points to review your investment mix should be sensibly diarised, whether quarterly, annually or otherwise. Your adviser will be able to guide you on this and will be available to continue to assist in shaping your asset allocation in order to achieve your goals.

How much risk are you willing to take?

Throughout this Guide, we have looked at the importance of your attitude to risk as a key factor in determining what kind of investment approach would be most suitable for you.
Understanding the level of risk you are willing to take is, however, only part of the picture. In providing advice we must also consider the level of risk you are able to take. In other words, while you may understand and accept that risk is necessary and you are willing to take that risk, are you able to cope with the consequences of the risk becoming realised? If the value of your portfolio dramatically reduced, what impact would that have on your standard of living? How would such a loss affect not only you but also your family or dependants? What would be the possible consequences of falling far short of your investment goals?
The emotional impact of loss is another important dimension in evaluating your risk tolerance. So, whereas you might well be able to withstand the financial consequences of a loss, how would you actually feel about it? Frustrated, angry or guilty? You should therefore consider the extent to which you might take an investment loss personally.

Having understood your willingness to take risk and capacity for loss, the advice process will include a consideration of the level of risk you should take to meet your stated objectives. An extreme example is used to illustrate the point. Let us say you wanted to invest £5,000 to achieve a lump sum of £20,000 in a few years time taking a very cautious attitude to risk (this approach is illustrated in Risk Descriptor A over). Here the advice might be to consider taking a higher degree of risk (perhaps as illustrated in Risk Descriptor C or D over) as investing to achieve this outcome at low risk is unrealistic. Of course you need to understand the consequences, both positive and negative, and be able to cope with them.
With any recommendation it is important that you are able to understand the risks involved. If at any point you are unsure or have questions your Chase de Vere adviser will be happy to help explain.

Why take investment risk?

The level of risk you are willing to take will have a direct impact on the returns that you may expect to make on your investment. In a certain scenario, you may experience a greater return (reward) from a riskier investment strategy but such a strategy will also have a greater potential for loss.
The risk vs. reward balance is the key aspect of your investment. It will help you to quantify your willingness and ability to accept risk and to determine the investment strategy that you will be comfortable with.

“There are risks and costs to action. But they are far less than the long range risks of comfortable inaction.’’
John F. Kennedy

Risk descriptors

At Chase de Vere we use a set of risk descriptors to help put investment risk in context.
The Chase de Vere investment philosophy is simply that we believe a properly constructed risk-based asset allocation approach is the best way to serve our clients’ investment needs, considering all of the issues we have looked at in this Guide.
In using the 4 asset classes explained earlier, we assess the risk presented by our asset allocation models according to the percentage of your money that is invested in risk assets (equities or shares). For example, for descriptor A that follows, the monetary value of capital should not change, so there is no capital risk, but you may be exposed to other risks (for example, inflation risk as explained earlier).
Whereas in looking at the final descriptor, F, where your money can be invested almost exclusively in risk assets, you can see that it is clearly subject to a far higher level of risk. As a consequence, you could lose all of your money.
Between these points the descriptors move from lesser to greater levels of risk in the investment approaches outlined to demonstrate the potential impact that needs to be considered. The descriptors will help you understand the level of risk you may be willing to accept.

You are not comfortable with the thought of investing in the stock market and would rather keep your money safe in the bank.

You have low levels of knowledge of investment matters and very limited interest in keeping up to date with investment issues.

You are aware that your money might not keep up with the cost of living and could be worth less in the future as a result.

You are not willing to see the value of your money go up or down in the short term.

You will feel very disappointed should investment decisions not turn out as you had hoped.

You do not generally like to take risk with your money, but you may be willing to make investments with a proportion of your available capital over a 5–10 year time horizon.

You may have some limited experience of investments, but will be are likely to be more familiar with bank accounts.

You can potentially suffer very limited losses.

Whilst recognising that investment values will change, you would feel very uncomfortable if your investments rose and fell in value very rapidly.

You will feel disappointed should investment decisions not turn out as you had hoped.

You understand that you will have to take some investment risk in order to be able to meet your long term goals.

You will have moderate levels of knowledge about investments and will pay some attention to keeping up to date with investment matters and the markets in general.

You can potentially suffer some loss of value on your investment.

Whilst recognising that investment values will change, you would feel uncomfortable if your investments rose and fell in value very rapidly.

You may feel disappointed should investment decisions not turn out as you had hoped.

You may be willing to consider taking higher level of risk with your money and understand that this is an important principle in terms of generating long-term returns.

You are a fairly experienced investor having used a range of investment products and services in the past. You have a good knowledge of financial products and you may pay regular attention to investment matters and the markets in general.

You may not get back the full amount you invested and a higher proportion of your money is at risk.

You accept fluctuations in the value of your investments are likely and this does not concern in the short term.

You may feel slightly disappointed should investment decisions not turn out as you had hoped.

You are willing to take a very high level of risk with your money and accept that whilst the risk to capital is high, the growth potential is excellent.

You are a very experienced investor having used a wide range of investment products and services in the past. You have a very good knowledge of investments and pay regular attention to investment matters and the markets in general.

You may lose a high proportion, but not all your capital invested.

Fluctuations in the value of your investments are commonplace and you accept this is a routine feature of investments subject to this level of risk.

Whilst you may be slightly disappointed should investment decisions not turn out as you had hoped, you are able to accept that occasional poor outcomes are a necessary part of long-term investments.

You are willing to accept the risk of very considerable loss of capital to potentially gain significantly higher returns.

You have a very high level of investment knowledge and a keen interest in the financial markets. You have made high risk investments in the past and routinely invest in the stockmarket.

You could lose all of your capital as the risk is extreme, whilst the growth potential is at a maximum.

You recognise that the value of your investments will increase or decrease significantly throughout the duration of the investment. You fully accept regular changes in the value of your investments.

You would not suffer from any disappointment if investment decisions turn out badly and can accept poor investment outcomes without difficulty.

What next?

Once you are sure you have accurately established your feelings toward investment risk using our Attitude to Risk Questionnaire, your adviser will help you decide upon an investment strategy that is suited to your tolerance for risk, as well as your proposed investment term, your investment objectives, the tax treatment of the investments used and any other factors that might influence the selection of assets.
Your adviser’s recommendation will be presented in detail in writing and include an explanation of the reasons the investment strategy is considered suitable. You should read this report carefully and make sure you fully understand the recommendations contained. These are investment decisions that can shape your future and it is important that you fully understand them, the rationale behind them and the risks that come with them.
It is hoped that this Guide has helped to explain some of the considerations and terms used in context of making an investment decision. Your Chase de Vere adviser will be pleased to provide any further help you may require.

0345 609 2002

client.services@chasedevere.co.uk

Chase de Vere Independent Financial Advisers Limited (registered in England Number 2090838) is authorised and regulated by the Financial Conduct Authority. A member of the Swiss Life Group. Registered office: 60 New Broad Street, London, EC2M 1JJ.

Chase de Vere guide to Investment Risk