Risk isn’t always about bad things happening to good people, according to Trevor Leydon, head of investment risk and portfolio construction, multi-asset with Aviva Investors. But he does warn plan sponsors that traditional risk management tools could be offering a false sense of security.
Plan sponsors have tended to manage risk traditionally, Leydon says, avoiding potential negative outcomes by focusing on tail risk. But if investors considered more efficient monitoring through the use of multiple timeframe modelling, with an additional focus on managing volatility, they may be more successful.
“I’m not saying if you use risk tools, you’re always going to make a total return that’s positive,” he says, “it’s about enabling you and empowering you to try to make that better decision.”
With volatility suppressed during the last two or three years, he offers two possible explanations. “One is that risk has genuinely disappeared from the system or, two, there’s something else that is suppressing it.” Leydon says plan sponsors can test this, if they think about a multi-timeframe volatility.
“By merely changing the framework in which I look at a volatility measure like value at risk, I can get a better understanding of risk. And, you can see how you can use a tool you use every day and reshape your universe.”
It’s also incredibly important for investors to start thinking about these methods of measure, he says, whether it’s daily risk reports where they’re analyzing multi-timeframe periods, or a weekly decision-making process with the investment boards on a longer timeframe and to make those working for you part of that process.
In a fireside chat, chief investment officer with OPTrust, James Davis, agreed with Leydon’s points on constructing a portfolio that questions assumptions.
“You can’t just rely on your asset mix in terms of managing your risk,” Davis says. “You also need to have plans in place so that you can dynamically adjust the risk when you feel that things are not behaving the way you had expected.”
He stressed the importance of diversification (typically during bad events) and says plan sponsors should question what kinds of things will protect them from the growth-oriented assets in their portfolios.
When asked about geopolitical events, Leydon highlighted Brexit as one with long-term and significant implications for financial markets. “There are other events, such as the U.S. election, that have significance for policy outlook, but they play out through different timeframes.”
Davis adds that it’s very difficult for plan sponsors to predict the outcomes of an event of that magnitude, so as a plan sponsor, it’s about bulletproofing of the portfolio — if opportunities do arise, a plan is in place to handle that volatility.
“Anything that will provide that sort of opportunity for you, if you can live through it, if you’re not concerned with needing your cash back today or tomorrow, then looking through these events, if you genuinely have that timeframe, it gives you an opportunity,” he says.
“If you have the cash, deploy it, but choose the moment wisely,” Davis says, “don’t try to catch the actual falling knife.”