Talking about risk can be tricky, as there are so many different categories of risk. This is why we are just choosing to highlight a few categories today. One of the more common measures of risk is volatility, or standard deviation, because it is a measurable value. When you measure volatility, you are effectively getting a gauge on how consistent your return will be year over year; an investment with a lower standard deviation will have less variance from a mean or average return, whereas an investment with a historically higher standard deviation may experience more upswings and corresponding downswings. It is important to remember, of course, that a fund’s past return is not indicative of its future return. Measuring standard deviation is based on historical returns, which can be somewhat limiting.
Beyond volatility, there are other types of risk that we would like to touch on. Concentration risk is one form that we encounter fairly often and that is the risk of having too much exposure to one particular sector, such as real estate, as an example. The danger here is that if there is a downturn in the market where you are holding a heavy concentration, your portfolio is going to struggle either with accessing liquidity or declining market values, among other potential issues.
Another big risk that we believe is right around the corner is market risk. In a way, this goes hand in hand with concentration risk. When investors have all their money in the stock market, it can be a wonderful thing – when you’re in the throes of a strong bull market. However, corrections or recessions will be ill felt with investors who are unprotected and over exposed.
A solution that can combat concentration risk, market risk and reduce standard deviation is through diversification. This is one of the main reasons why we set out many years ago to build out a suite of products that are uncorrelated to each other. At Capstone, our clients’ balanced portfolios have a combination of traditional investments – which could include stock exposure, but also include non-traditional exposure to such alternative asset classes as real estate, farm land and infrastructure. It is this diversification which we believe will properly protect clients, while providing several unique sources of return.
Janet Kim Sing, Portfolio Manager
Capstone Private Wealth