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What risks in stocks does the Portfolio Constructor/Optimiser manage?

All investments carry some level of risk. Investing in the share market has higher risk than many other asset classes. You can expect to receive an appropriate reward for the level of risk that you take. Some risks are diversifiable (holding a portfolio of stocks) vs non diversifiable risk (put it all on black). Academic studies show higher risk = higher return over the long term. But then how long term is your long term?

Portfolio Risk is the risk that the return you “expected” to receive is actually not achieved

The Constructor and Optimiser tool tries to manage these common risks?

  1. Volatility of the portfolio
  2. Volatility of individual stocks
  3. Being able to generate enough income from your stocks

Ways to manage the volatility of the Portfolio

Be benchmark aware: This investor is concerned about risk relative to the broader market in that they believe the market does well over the long run and does not want to miss on that long term performance. Therefore they wish to minimize the risk of not running with the bulls

Minimise absolute risk: When an investor is concerned about losing money on the share market they wish to minimize absolute risk. They prefer their portfolio to act in a stable manner and is willing to sacrifice capital gains to maintain an element of stability

No preference: Investing in great businesses offers investors the best chance of long term outperformance. This may mean that an investor takes on more risk to have the potential for above market returns. Therefore they are not too concerned if their returns vary from the market and nor do they mind if there is an element of volatility in the portfolio

Volatility in individual stocks

All individual stocks carry an inherent level of volatility about them. This could be due to a number of factors such as trading sentiment, lack of liquidity leading to large buy / sell spreads, small market caps etc.

It is important to remember that a stocks volatility does not only measure a stocks propensity to fall, but also to go up.

Investors looking to outperform can choose to focus on stocks that have a higher Beta. The Beta should not be a sole focus. Rather it needs to be considered with an investors weighting towards managing either absolute or benchmark risk. The balance of these risks defines the ‘marginal contribution to return’.

The ability to generate income from your stocks

Income investors seek an immediate return from their investments in the form of dividends. If the portfolio is skewed heavily to stocks that don’t pay a dividend then the risk of failing to receive an acceptable level of income increases.

However as is the case with volatility, it is NOT about income at all costs ie Be wary of capital killers and fundamental underperformers.

A measurement of all these risks as a collective, understanding the relationship stocks have with one another and then the ability to sort, rank and disseminate this information in an easy to view and understand format will revolutionize the way you invest forever.