Despite all these varying manifestations of risk, portfolio construction frequently takes the purely mathematical view and considers only volatility. This can lead to portfolios over-allocating to assets whose risks do not materialize as high volatility levels or under-allocating to assets whose high volatility levels are not indicative of risk.
How to appropriately measure risk will depend on the definition of risk, which will in turn depend on the context and investor’s objective. As more “risk managed” strategies make their way to market, investors should ask, “which risk?” and quickly follow with, “and how is it measured?”
Risk is a complex topic. In an upcoming panel discussion (S&P Dow Jones Indices Financial Advisor Forum in New York City tomorrow), we’ll be looking to take a deep dive on the topic, hopefully starting with the deceptively simple “what is risk?” and moving on to more complex topics, including ways in which we can measure and manage it.
[1] http://ssrn.com/abstract=2318961 or http://dx.doi.org/10.2139/ ssrn.2318961
[2] UBS Investor Watch report 1Q 2014
This article was written by Newfound Research co-founder Corey Hoffstein.
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