Why we wouldn't avoid investment risk even if we could

That's the thing about risk, explains Andy Brown, investment director at Prudential’s Portfolio Management Group, we spend our lives trying to avoid it little knowing that, without it, we can expect to gain almost nothing.

Over the past two years, the very mention of the word “risk” has been sending shivers down the spine of many the investor or IFA. Indeed, when talking about the concept, it is most likely to be discussed in terms of how to avoid it or, if you are feeling daring, its total elimination.

Yet, is it ever possible to totally avoid risk? And is it actually a good idea to seek a total risk free portfolio? While no one would recommend a kamikaze approach to your finances, one thing that strikes me is that it is not possible to achieve returns without it. Indeed, I would go so far as to say that it is the main driver of returns and should not be regarded as a rather unfortunate by-product.

That does not mean that risk cannot be reduced but, on doing this, it should be understood by all concerned that it also reduces the potential returns for the client. For an adviser trying to balance this inconvenient truth with an understandably more cautious client, this presents a real conundrum.

Allocation tools

So what can be done? First of all, an IFA needs to avoid the potential bear traps in their path – first and foremost, there are the tools that assess the optimal asset allocation. These are not bad in themselves but they do use historical data when coming up with their recommendations – anyone with more than a passing acquaintance with investments will be aware that past performance is not an indicator of future returns. So while they can be used as a starting point for a conversation, they should not be used blindly.

Which brings us to the role of the adviser – it goes without saying that IFAs play a very important role in the whole investment process but it must be stressed that is a process. To use some construction terms, it should be the markets that do the heavy lifting while the fund manager is the one who does the spade work in terms of finding specific opportunities for their investors. Meanwhile, the adviser should be the one who informs this chain by providing the necessary input on, not only what a client needs in terms of return, but also how this should be balanced with their risk profile.

A link in the chain

To create an entire proposition for a client is not a simple task and an adviser should not attempt to try and replicate what a FTSE 100 company can produce. To be quite frank, it just will not work as a one man band does not have the same resources. On this basis, an IFA should view themselves as an important link in the chain between the investor and the investment team. An adviser should look to ensure the right people are in place and, once assembled, that they have the correct insight into the client on whose behalf they are investing or working.