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Keith Edwards
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Risk

Investing in securities involves taking risks, both to your capital and to its potential to provide you with income. Some of the risk warnings now seem rather bland, simply because we have heard them so often. And they don’t really contribute much to a decision as to what level of risk is suitable for you.

Appetite for risk

It is very important to us that you fully understand the nature of the risk arising from different investments and portfolio structures. Our aim is to manage your portfolio to the aims and objectives that you have set, but also at a level of risk that you are comfortable with and that is within your ‘risk tolerance’.

Importance of time

Investing in the financial markets for gain involves some degree of risk. Over the last fifty years, investing in the ordinary share capital of good quality companies has provided excellent returns to investors in a combination of both capital and income growth. Over shorter periods the opposite has been true on a number of occasions, and the last few years are a good illustration of this. Equity investment should only be undertaken with a long-term view in mind, at least five years.

Risk and diversification

The ordinary share capital of a company is, by definition, risk capital, so, those who are risk averse should generally not invest in equities. Different classes of investment have different risk characteristics; some are much riskier than others. Risk can be reduced significantly by diversification amongst the shares of different companies and industry groupings. But this will not remove the risk of the general market.

Asset allocation

One of the key aspects to this is what is known as the asset allocation. At root, this is the split between the major asset classes: cash, fixed interest securities, ordinary shares (equities) and property. It is important to maintain sufficient cash on deposit for any short-term requirements or emergencies; along with whatever further sums you feel comfortable with. We would not include such amounts in your investment portfolio, although our banking colleagues would be delighted to assist. Most of our clients own their own homes, but we do not advise on property. The long-term investment portfolio that we are discussing here is that part that is available for investment in fixed interest securities and equities. Once you have established an asset allocation that is appropriate for you, we would not expect it to alter a great deal, indeed frequent changes tend to be counter productive as they incur extra costs. Of course, over time, it is likely to be most appropriate to lower your risk level, perhaps as you approach retirement and require a more certain income.

Risk Scale

At Church House, we manage investment portfolios according to a nominal 1-10 scale of risk; where 1 represents cash on deposit with a reputable bank and 10 is essentially gambling:

At the strategic asset allocation level, this scale reflects our expectation of likely portfolio volatility in normal circumstances. So, at level 3, a portfolio would be invested roughly 50% in high grade fixed interest securities (eg Government Gilts) and 50% in ‘blue chip’ UK equities. At level 8, a portfolio would be entirely invested in equities including a large proportion of overseas equities and smaller companies. Most of our portfolios fall in the 3-8 range, with the majority at 5/6. 3 and 4 are what would traditionally be known as ‘income’ portfolios, 5 and 6 as ‘balanced’ portfolios and 7 and 8 as ‘capital growth’ portfolios. We also manage lower risk portfolios in the 1 and 2 areas, to specific briefs. We do not operate at the 9/10 levels.

Having your cake and eating it

It is important to remember two things: If you require a higher level of income, you must appreciate that this will be at the expense of capital growth opportunities; and risk and reward do go hand in hand; it is not possible to combine low risk with high potential for capital growth.

The risk questionnaire

At Church House, knowledge of our client’s risk-tolerance is something we rate as almost the most important piece of the knowledge that we can have about you. It defines your relationship with us in terms of what you are expecting to see from your portfolio. So, to help us and you establish what your attitude to risk actually is, we have developed a straightforward risk assessment model in the form of a questionnaire. Risk-tolerance varies with each individual according to their overall investment objectives, investing experience, personality and other characteristics. Reviewing your answers is part of the learning process for both of us in establishing exactly what you want from us in terms of the risk management of your portfolio.