Wednesday, 31 August 2016 - 20:00

 

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Seed Weekly - Low Risk Investment Strategies

In my last article, I discussed investors investing into negative interest rate investments and looked at a number of reasons why investors, in this case mostly institutional, would consider such an investment.

All investing involves a degree of risk. The question that investors need to ask themselves is firstly how can I define risk, and secondly what level of risk am I satisfied to take on. From this starting point, once the various investment options have been identified, a portfolio can be constructed.

The stylised chart below reflects a range of investment assets (not exhaustive), plotted on the risk and potential return scale.

While the potential for a higher return can come from a riskier investment, most investors understand by now that there are no guarantees to that return. In fact, often the reverse is true in that less risky investments can and have outperformed more risky investments over long periods of time.

Warren Buffett’s famous axiom on investing is “Rule number 1, never lose money and rule number 2, never forget rule number 1.” At its core, this rule of investing emphasises the return of capital, ahead of the return on capital. Another way of looking at it in the light of a definition of risk, is “avoiding the permanent loss of capital.”

In a high growth rate, inflationary environment, where asset prices are generally moving up and liquidity is in abundance, investors will tend to forget about the return of capital and focus more closely on the return on capital, but when risk escalates sharply, capital preservation suddenly becomes paramount.

Because we live in a world with both known and unknown risks, the question is not so much one of whether lower risk investments be included into a portfolio, but to what varying degree they should be included. When constructing a diversified portfolio of investments, a portfolio manager should look at including a range of lower risk investments in order to reduce the variability of the portfolio’s return, reduce downside risk, and importantly be in a position to take advantage of price volatility in growth investments when they are sold down, becoming more attractive and therefore by definition “lower risk.”

Considering the range of lower risk investments, these are some of the options:

• US Treasuries or the US Dollar
• Developed market government bonds – e.g. US, Switzerland, Germany
• Gold bullion
• Other precious metals such as silver and platinum
• Quality, low volatility shares

The challenge for investors is that like riskier investments, low risk investments also go through sometimes long periods when they do not necessarily act as a safe haven. For example, BCA Research analysis has found that US Treasuries have been a good safe haven from 2000 until now, while gold from that time became too correlated with the market returns. More recently, however, it has been acting more like a lower risk hedge with low to zero correlation to the market.

This is, therefore, one reason why portfolio construction is not necessarily a static process.

Kind regards,

Ian de Lange

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Wed, 31 Aug 2016

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