True or False: “Risk is something to be avoided”
Striking the right balance of specific risk exposures — both at the asset class and overall portfolio levels — can mean not only increased returns in favorable environments, but also limited losses during unfavorable ones.
For example, stocks tend to experience material losses when the equity market drops; we call this equity market risk. Investors are still willing to own stocks despite such volatility because stocks have historically delivered elevated annualized returns.
Bond investors may be familiar with credit risk, which is a measure of how likely a borrowing company will be to make its interest and principal payments. High yield bonds offer more income than investment grade bonds to compensate for greater credit risk exposure.
The act of pursuing and maintaining risk exposure runs against investors’ instinct to prevent capital loss, however temporary. As such, risk management not only works to minimize risk exposures that fail to adequately compensate investors, but also encourages risk exposures that we believe are more likely to be rewarded.
Our culture and principles
Even the most skilled investors can use help maintaining objectivity when balancing risk exposures. We therefore believe it’s important to separate portfolio management from risk oversight, as we do in our Investment Management Unit (IMU).
Our risk management team operates autonomously, decomposing every security and portfolio down to a set of risks (or, in more technical terms, systematic, economic and market factors that explain the variability of a security’s returns). This risk model helps us answer several questions:
- Are the risk factors consistent with the fund or strategy’s mandate?
- Is their presence intentional?
- Do they represent excessive exposures?
This is not to say that our portfolio managers and analysts are not also responsible for monitoring and managing risk budgets. While our risk management team conducts analysis independently, it is also tasked with educating our investment teams about risk sources and metrics. We are each risk managers in this sense. This shared understanding and responsibility forms the basis of our culture.
Download the full paper for a closer look at the elements of our investment philosophy, including goals-based investing; asset allocation; manager research; operational due diligence; governance, culture and technology; and monitoring and measurement.Download the paper