Risk Versus Reward

Risk is a subject we could discuss at great length because many of the long established norms are presently ready to be consigned to the rubbish bin. At time of writing (Nov 7th 2007) it is 9 years almost to the day since Russia defaulted on its loans and oh how things have changed since then.

In 1998 it was generally regarded that the US would be a safer place to invest that Russia. Now it is the US with the huge deficits, a currency growing weaker by the week and a huge sub-prime loans fiasco originating in its banks and reverberating around the world. As a direct result of this we saw a run on UK bank Northern Rock and investor deposits were only safe-guarded by intervention from the Bank of England. Who wouldn’t have said that a bank account was a very safe place to put one’s money? Ultimately no depositor lost money but had this happened on a larger scale, who knows what may have happened?

Now we have Russia with no external debt and very robust public finances and investors there since the default 9 years ago can measure their returns in terms of several hundreds of percent. We can also see how China has prospered and opened its doors to inward investment and investors there have also made a killing far in excess of what an investor in developed markets would have made over the same period.

In 1997 we had what was called “the Asian Meltdown” where Asian currencies and stock markets were in crisis. Now we have Asian countries with large surpluses and have moved from debtor nation status to creditor nation status whereas Western countries have in many cases exchanged roles. As a Morgan Stanley analyst wrote this week about the 1998 Russian default, “Since then it is almost as if the patient has got well, been to medical school and has now become the doctor”.

We therefore live in times where it is perhaps easier to define volatility than risk because volatility might be defined as a shorter term phenomenon whereas “Risk” has more permanent connotations. At Offshore-Rebates.com we recommend funds based on our perception of markets and a fund or manager’s ability to make money in a given opportunity rather than simply stating that (say) “the US is a safer place to invest than (say) India”, or that because bonds react badly to interest rate rises we may in a rising rate or inflationary environment consider bonds likely to be a poorer investment to say equities or a market neutral multi manager hedge fund.

However because people like to know roughly where they stand and based on conventional theory I have compiled the following. It is not exhaustive nor intended to be so, but is intended solely as a guide to accepted norms.

Risk Level 1
A Bank or Building Society Account
A Money Fund

Risk Level 2
A with profits Fund
A major markets Bond fund such as Gilts or US Treasuries.
Momentum Allweather Fund and its ilk.
A Cautious Managed or Balanced Fund combining bonds with equities. (Can be more a 2.5 - varies with management group)
A Capital protected fund (but not in all cases)

Risk Level 3
Global managed equity funds.
High Yield Bonds (can be 3.5)
Some Hedge Funds (can be 2 to 5)
Global Trackers (3.5)

Risk Level 4
Single market funds such as trackers or managed funds invested in just one country.
Thematic funds with a wide mandate. (Can vary depending on management group)
Small Companies Funds.
Emerging markets funds (4.5)

Risk Level 5
Technology Funds
Biotech and Pharmaceutical
Telecoms Funds
Healthcare Funds
Warrants
Emerging Market single country funds
Global Resources Funds
Gold and Mining Funds

The above is not definitive but should give you an idea. We will tell you where on the above risk scale any recommendation falls.

You should also be aware that just because funds might have similar names that they are not directly comparable. One leading technology fund concentrates on small and medium cap' stocks, whereas it's biggest rival invests in large cap' stocks. This is commonplace and the uninitiated are easily mis-led.