Are advisors thinking about risk in the wrong way?

Analyzing risk tolerance is one of the most important aspects of an advisor's role

Are advisors thinking about risk in the wrong way?

Analyzing risk tolerances is an important part of an advisor’s role. No two clients have the same appetite for risk and good advisors have discovered the value of taking the time to understand each client’s personality.

Some clients will seek out low risk investments in an attempt to safeguard capital, while others realize that not being fully invested can sometimes be just as risky as securities further along the risk spectrum.

Even how risk is defined can split opinion. Many investors define risk as volatility and the expected change in the value of a security. Talbot Babineau, CEO of IBV Capital, sees things a bit differently

“The market assesses risk on the basis of volatility, or the degree of change in the value of a security over time. While this might be useful in some cases to quantify, compare, model, and explain risk, it often does not reflect the reality of what the security is worth,” said Babineau. “This is the critical flaw with volatility - it doesn’t consider what a security is worth, relative to what it’s currently trading for when it quantifies risk.”

Babineau has nearly a decade of experience in equity, fixed income and commercial real estate investing and describes his strategy as being “contrary to conventional investing wisdom.” For him, assessing and managing risk is the most important aspect of investing.

“How we define risk has a material impact on how we invest and on the composition of our returns,” Babineau said. “Why is this so? While many avoid volatile securities, since market participants associate volatility with risk, we do not – if the securities are attractively priced and exhibit the business characteristics we find so appealing.”

Babineau manages the IBV Capital Global Value Fund, which takes an absolute value investment approach that primarily focuses on opportunities in developed markets. It pursues its investment objective by investing on the long and occasionally short sides in equity, fixed income, and their related securities.

“We don’t see a need to actively manage the level of volatility of our portfolio; to do so would in no way reduce the actual level of risk associated with our investments,” he said. “Our approach may, during distinct periods of time, result in us owning volatile investments and consequently experiencing volatile portfolio returns. However, in the long run, executing our investment approach mitigates actual risks while producing promising potential returns throughout all market conditions.”

Related stories:
Time for active management as risks return, say institutional investors
Advisors, do you know your clients' real risk appetites?