Lowes Magazine Issue 115

DOUG’S DIGEST

What is risk? This is an important question for the Investment Team, says Investment Manager Doug Millward

movements we would expect to see. For the FTSE 100, most monthly returns are in the range of plus or minus 4%. February saw twice that, and March more than three times. Even looking at the Investment Association’s Mixed Investment 20% - 60% shares sector average, which contains funds with no more than 60% invested in company shares and as such is seen as “less risky”, that went from a typical range of +/- 2% to -10% in March. Prior to lockdown, the biggest monthly fall for the average of this sector over the last five years was -3.01% whilst the maximum monthly gain was 3.89%, a range of 6.90%. March and April saw that move to -9.99% to 5.68%, a range of 15.67%. So from a purely statistical point of view the investment is much more risky, but from a longer term, more common-sense point of view is that true? Well, of course the world could go into lock-down again causing a similar movement, but again we would expect that to be short term. We have always said that an investment should be made for the medium to long term, at least five years, and when looking at that time frame we believe that our definitions of risk will still be valid. Which is where the debate has arisen. Our statistical measure says investments have potentially become riskier and therefore consideration should be given to making adjustments. Our common sense however says this is a never before seen anomaly and whilst it could happen again, it certainly isn’t the new normal. Reacting now is reacting after the event and selling after the market has fallen will only deny investors of the chance to benefit from the ensuing recovery, crystalising any short term losses. We are therefore doing a lot more work on this subject to make sure that no client’s investments are exposed to more risk than they are comfortable with, whilst being careful not to make a knee jerk reaction to short term extremes. We will be in touch if we feel any changes need to be made to your portfolios and as always, your Consultant will confirm the suitability of your existing investments as part of your regular review. Rest assured though that we continue to monitor your investments, leaving you to focus on the things that are truly important in these very strange times.

A BIG TOPIC OF CONVERSATION IN THE investment Department lately has been ‘What exactly is risk, and how do we measure it?’ For many years now, Lowes have had written definitions, refined over time, which we believe explain in simple English what our different risk levels mean, and we are confident that these definitions still hold true today. A written definition is all well and good, but when it comes to deciding what risk level an investment portfolio sits in, a quantifiable measure is needed to make a consistent allocation. There are several measures that could be used based on historic information, such as “maximum drawdown” as an example. This records the maximum potential loss of capital that could have been sustained over a set period, if an investor had bought at the very top of a peak in performance, and then sold out when the portfolio was at its lowest subsequent value. This would of course mean that the investor had been incredibly unlucky, so a more realistic measure is to look at how far away from its average value an investment can be expected to move over a given period, and this is one measure we use at Lowes when it comes to assessing collective investments. We look at the monthly returns over the last three years, and apply a statistical measurement called Standard Deviation, which basically shows how spread out those returns are, compared to the average. A high Standard Deviation means that the performance of the investment is more volatile, and can rise or fall significantly over the short term. A low Standard Deviation means the performance is less volatile, and is less likely to vary. So we measure this for a fund or a portfolio of funds, and then compare it to the average of all those available to quantify how “risky” that investment is and map it to our written definitions. A process which has stood the test of time. So why has this become such a hot topic? Well as you might guess the current pandemic and the consequent lock-down of many countries and economies, has had a significant short-term effect. As can be seen from the accompanying charts the falls seen in the run up to lock down in the UK were much larger than the usual monthly

[Source of all performance figures: FE Analytics]

Monthly performance FTSE 100 and IA Mixed 20%-60% Sector July 2015- June 2020

8 6 4 2 0

-2 -4 -6 -8

% return

-10 -12 -14 -16

FTSE100 IA Mixed 20% - 60% Sector

Jan 16

Jan 17

Jan 18

Jan 19

Jan 20

Mar 16

Mar 17

Mar 18

Mar 19

Mar 20

July 15

July 16

July 17

July 18

July 19

Sep 15

Nov 15

Sep 16

Nov 16

Sep 17

Nov 17

Sep 18

Nov 18

Sep 19

Nov 19

May 16

May 17

May 18

May 19

May 20

Month

Lowes Financial Management is authorised and regulated by the Financial Conduct Authority. Visit: www.Lowes.co.uk | Call: 0191 281 8811 | Email: enquiry@Lowes.co.uk

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