The intensity of news flow recently has made events that happened only days ago feel like they took place in the distant past, and recent history – months or even years - is all but forgotten. Amongst all this noise, what many may have missed is that we are increasingly confronted with a diverse range of risks that have been hiding in the shadows for years.
As the coronavirus pandemic has unfolded, we have been reminded of the basic principles of risk management that have conveniently, and often intentionally, been overlooked.
Although the virus was initially regionally concentrated, as China went into lockdown global manufacturing supply chains seized because manufacturers all around the world had prioritised convenience and efficiency, overlooking the importance of diversification.
Diversification is often described as “the only free lunch in finance”, and yet, it is something a number of investment managers may have overlooked as they concentrated their investments on the latest “best thing”. How did they fare as markets started to adjust?
As the crisis deepened, we were viciously reminded about market risk which had largely been forgotten since the lows of the GFC in 2009. As interest rates declined, and remained lower for longer than most anticipated, investors increased risk, allocating greater portions of their portfolio to lower grade credit and more risky equity holdings – for over a decade, they were rewarded for this. The recent market drawdown will have a lasting impact, particularly for retirees, or those nearing retirement.
Liquidity risk has also been exposed by the coronavirus related sell-off, as the financial plumbing – particularly in the credit markets - became blocked in a way that is directly comparable to the manufacturing supply chains. Many investors who required access to their own capital, being held as a “low risk” allocation in their portfolio, have been severely penalised as fund managers increased the costs of redeeming their holdings. In some cases the increase was over 10 times, often exceeding the expected return generated by a full year of investment.
But coronavirus isn’t the only recent topic to expose investors to a range of risks that were previously subdued. Some had been largely out-of-sight and out-of-mind, such as ethics and governance, but others like climate change – many had just chosen to ignore.
The recent bushfires served as a reminder of climate change risks. Climate change matters an awful lot to some investors, and we increasingly understand the power that investors have in influencing corporate agendas and bringing about positive change.
The Hayne Royal Commission provided a costly reminder that ethics and corporate governance are risks that require management. The failure to do so cost the Australian public an untold fortune over many years, and more recently, Australian institutions tens of billions in fines and reparations – a cost that was ultimately borne by the millions of Australians holding shares in these financial institutions.
Risks like governance and climate change are classified by investors into an environmental, social and governance (ESG) framework which aims to incorporate the financial relevance of these factors into investment decision making processes, as these factors impact long term investment returns.
The problem faced by investors who are forced to assume more equity risk in a low interest rate environment hasn’t disappeared through the recent bout of volatility. In fact, it becomes even more severe as central banks around the world have reduced interest rates to stimulate the economy through Covid-19 related shut-downs.
Regardless of life stage, risk tolerance, financial well-being, or ethical preferences, investors who require investment returns to fund their future expenditure have little choice but to include equities in their retirement, or even post-retirement, savings.
But investors aren’t without options, and a number of high-quality fund managers have appropriate products for risk aware investors.
At Pengana Capital Group, the focus of most of our funds is growing long-term wealth as well as capital preservation. However, we don’t believe in the one size fits all approach and take pride in offering investors a product range designed to meet a variety of risk profiles and risk preferences. This is exemplified by our International Equities strategy which adapts its core process to meet a range of investor requirements, you can find more information at the full article on our website here: https://www.pengana.com/news-and-insights/pandemic-reminds-investors-of-some-basic-principles-of-risk-management/