We asked two fund managers about risk. Here's what they said:
Kunal Desai, Emerging Markets Portfolio Manager at GIB Asset Management
Managers usually say inflation is the biggest economic risk at the moment, but what do you think? Which risks are under-appreciated?
Geopolitics remains an underappreciated risk, particularly the fallout between the US and China and each side’s action plan towards Taiwan. Taiwan is blessed with a truly global and innovative industry in the form of semiconductors and its value chain, which means any disruption to production and distribution would have a severe global impact.
On a broader level, how do you understand risk as a manager? And on a portfolio level, is the biggest risk capital loss or failing to meet investment objectives? Is volatility a risk that can’t be avoided in today’s markets?
Our approach to risk is to minimise systematic risk as far as possible and expose stock-specific risk in line with our convictions. We wish to expose deliberate factor exposure in areas where we have conviction. This includes certain sectors, business models and companies lower down the market cap spectrum, which we feel are misunderstood.
On a practical level, how do you manage risk in the fund, especially after bonds underperformed last year? Do you have to take more risk with asset classes to reduce overall risk?
Our overriding principles are to capture the right factor exposures by seeking to mitigate those where our views are undifferentiated and seek active risk and deliberate exposure to factors which are underwritten by our fundamental, bottom-up, characteristic-driven investment process.
In particular, we seek to neutralise country and foreign currency, style, volatility, valuation and liquidity risk, achieved through the use of in-house portfolio and risk management tools. In contrast, we seek deliberate factor exposure to industry, business and size risk.
We drive bias towards industries and business models which can control the levers that drive earnings and cashflow growth whilst avoiding sectors and businesses which are highly cyclical, highly regulated with limited control of cashflow levers and unsustainable capital structures.
We also seek high relative exposure to small and mid-cap companies, given the compelling opportunity they offer versus their well-understood large-cap peers.
Iain Cunningham, Co-Head of Multi-Asset Growth at Ninety One
What do you think the biggest risk is at the moment – managers usually say inflation – But what would be an unappreciated risk?
The biggest risk for investors at present appears to be the underappreciated likelihood that developed world inflation will remain sticky at a time when growth and earnings begin to slow. We expect inflation to remain sticky due to ongoing tightness in labour markets and resulting wage growth, while we expect growth to begin to suffer the consequences of the largest and most rapid hiking cycle in many decades. This would imply that central banks will be unable to ease as growth weakens and recession in the US and Europe is our central scenario over the next 6-12 months. At present we believe the market is complacent to this - currently pricing an ongoing deceleration in inflation, expected to allow the Fed in particular to ease, and a soft landing of the economy.
On a broader level, how do you understand risk as a manager – and on a portfolio level, is it capital loss, or failing to meet investment objectives? Is volatility a risk that can’t be avoided in today’s markets?
We view risk in two ways: firstly, the risk of suffering permanent capital loss in an individual investment. Secondly, the path of returns of an overall portfolio – driven by prospective correlations of individual positions and resulting total ex-ante volatility. The latter is particularly important in strategies that utilise higher levels of gross investment exposure.
On a practical level, how do you manage risk in the fund, especially after bonds underperformed last year? Do you have to take more risk with asset classes to reduce overall risk?
We believe that risk management should be integrated at every stage of the investment process and be forward looking. Buying assets that are beneficiaries of longer-term tailwinds, seeking to ensure that the cycle is set to be supportive and not overpaying for assets are all important aspects of managing risk through our investment process. We then think about what the prospective growth and inflation regime means for asset correlations, and to what degree diversification is available – we don’t purely rely on backward looking risk models and optimisers. On a forward-looking basis we believe government bonds can no longer be relied upon as buy and hold diversifiers due to a different prospective regime over the next five-to-10 years. We view government bonds as more of a tactical asset class.
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