Well, here we are, Autumn is upon us, and we haven’t had a heat-wave since before the school holidays began: it must be time for an ‘Indian Summer’ now! Since my last piece, the markets have acted in a typically volatile fashion, yet have ended up pretty much the same as they were. I shall have more to say about the year’s ups and downs in the next issue, but now on to the conclusion of my comments on the subject of risk. This final part concerns equities, or shares as they are probably better known. As I have mentioned before, shares are the means by which the ownership of companies is allocated between individuals and corporate or institutional investors. Shares, by their nature, have an inherent risk. Not necessarily the ‘absolute’ risk of total loss, though this can happen, but they have always been regarded as a greater risk than Bonds.
Other than the basic risk involved in investing in any company – that of the company failing – there are several others that may have an effect on your capital. Economic, political and market factors can combine to have an (almost) daily effect on share prices. Adverse information regarding a country’s economy, such as unemployment, production, and local interest rates, may all affect the performance of particular shares. Political uncertainty, and the possibility of a Government that may not be sympathetic to certain kinds of business, will similarly affect share prices. An example of market risk might be the possibility of an increase in commodity prices. Currency risk is not just confined to overseas equities. If businesses rely on imported goods, or materials, then an adverse movement in currencies could increase costs, and therefore profitability. Similarly, if it deals predominantly in overseas markets and has income that is principally in foreign currencies, this is also a potential risk. Geographical risk may come in several forms, that of climatic, natural phenomena or meteorological risk in certain areas, regime change, ‘westernisation’ or its slowdown, or a change in a country’s demographics.
Sector risk is that which may affect one particular sector of a market or markets, such as manufacturing, pharmaceuticals, commodities, services, or, particularly relevant of late, financials (and more specifically, Banks). This risk may also spread across different geographical areas, and is not necessarily confined to a specific locality.
Finally, we come to concentration risk. This is the risk of “putting too many eggs in one basket”. An important part of successful investment planning is diversity: any well-balanced portfolio should have a decent spread of assets, and any concentration in one particular type of asset, geographical area, or sector is, in itself a potential risk. One last note about risk: that being, time is not only a great healer, it is a great reducer of risk. The greater the time you have over which to invest, the more risk you are able to accept in order to increase the potential rewards. The closer you are to retirement, the lower the risk profile of your investments would tend to become.
Well, I’m going to risk nipping out into the howling gale and pouring rain, for a pint of milk. Oh to be in England, now that Summer’s gone!