Risk Measurement

chiang_mai

I frequently assess my portfolio for risk and use various ways to try and measure risk. If I use Morningstar's risk methodology, only 21% of my holdings are higher than the average risk. If I use the KiiD definition of risk over 58% of my holdings are above average risk. If I use Trustnet's comparative risk methodology the results are more closely aligned with the KiiDs but are still quite different. Granted there are lots of different types of risk, geographic, asset mix, duration, capitalisation, currency, market etc etc. My question is, what is an appropriate system to use to try to assess overall portfolio risk, one that will give a meaningful indicative (not precise) measure of portfolio risk? Or is this a futile exercise?

maxsteam

Most "risk" statistics simply measure historical volatility. There is an argument that volatility in the past implies the likelihood of volatility in the future which implies a risk to your portfolio. It's a fairly woolly argument but it's the best that there is.

There is a risk that, for example, a company in an undemocratic country may fall out-of-favour with their government or that a company with high debts may become insolvent. These risks are not specifically assessed in the statistics that you mention. The statistics simply measure recent volatility. Personally I prefer to look an equity's beta as this admits to being a measure of volatility rather than pretending to be something else.

JohnWinder

If you're saying '21% of your holdings are above average risk' doesn't get you very far in understanding their risk, then I'm right with you there.

Volatility of price, and maximum price collapses might be more informative. Standard deviation figures for volatility are easily found. Early last year we saw a 35% price collapse, now just about recovered. It was 50% down in 2000 and 2007, taking several years to recover. https://earlyretirementnow.com/2020/03/

Reflect on Bernstein's 'deep' risks for assessing your portfolio: inflation; confiscation by government; geopolitical (war); market collapse (China in 1949, Russia in 1917, Cuba in 1954); deflation. To guard against, he suggests considering which are most likely and  paying more attention to those. Inflation: diversified equities are good, but not in the short term for which you need linkers. Confiscation: overseas property. War: equities bounced back after 15 years in Europe and Japan. Deflation: local stocks can suffer badly; cash, nominal bonds and overseas shares can help.  Market collapse: diversification of markets.

Something to read here: https://www.bogleheads.org/wiki/Risk_and_return:_an_introduction

dunstonh

KIIDs do not have the lowest score as cash.  So, expect their risk scale to be out of kilter with others that do have the lowest point as cash.   FE has a changeable risk scale that is updated quarterly.   The FE numbers start with cash and have the FTSE100 as 100.   All funds then workaround those two points.      FE can then show the weighted risk score of holdings without diversification benefit and with diversification benefit.     The latter being the one to use.

However, because the way the FTSE100 is not a constant risk score, that means the FE portfolio risk scores move around.   For example, this quarter and last quarter moderate risk was 50-60.    The quarter before that it was 55-65.  The quarter before that was 60-70.      And that is a weakness in the FE scoring method as only one of the two points is fixed (zero).  The other is variable (100).  You have an elastic band type affect. where you can stretch and contract.      It works if you understand the mechanism and how investments work but it can be confusing if you don't.

chiang_mai

Some very useful points, especially about KIIDs and cash....thanks.

coyrls

chiang_mai said:

I frequently assess my portfolio for risk and use various ways to try and measure risk. If I use Morningstar's risk methodology, only 21% of my holdings are higher than the average risk. If I use the KiiD definition of risk over 58% of my holdings are above average risk. If I use Trustnet's comparative risk methodology the results are more closely aligned with the KiiDs but are still quite different. Granted there are lots of different types of risk, geographic, asset mix, duration, capitalisation, currency, market etc etc. My question is, what is an appropriate system to use to try to assess overall portfolio risk, one that will give a meaningful indicative (not precise) measure of portfolio risk? Or is this a futile exercise?

Morningstar risk ratings are relative to the category of the investment and so cannot be compared across categories.

chiang_mai

coyrls said:

chiang_mai said:

I frequently assess my portfolio for risk and use various ways to try and measure risk. If I use Morningstar's risk methodology, only 21% of my holdings are higher than the average risk. If I use the KiiD definition of risk over 58% of my holdings are above average risk. If I use Trustnet's comparative risk methodology the results are more closely aligned with the KiiDs but are still quite different. Granted there are lots of different types of risk, geographic, asset mix, duration, capitalisation, currency, market etc etc. My question is, what is an appropriate system to use to try to assess overall portfolio risk, one that will give a meaningful indicative (not precise) measure of portfolio risk? Or is this a futile exercise?

Morningstar risk ratings are relative to the category of the investment and so cannot be compared across categories.

Another useful point to consider, thanks. It would be useful if they had an equivalent rating system that assesses the risk of one category versus another, but what would be the baseline, cash perhaps.