Post Modern Investment: Facts and Fallacies of Growing Wealth in a Multi-Asset World

Chapter 9

Risk Management

An Oxymoron

In Chapter 8, we noted that for many investors, portfolio creation is based primarily on the well-known and often used mean-variance asset allocation model. We also pointed out that over the past 30 years, there have been major advancements in financial products (e.g., options and futures) and product design (e.g., portfolio insurance, option-based risk management, targeted mutual funds), which have attempted to directly manage a portfolio's expected volatility.

It is a truism in investments that it is easier to forecast risk than it is to forecast return. Unfortunately, it is also a truism that individual investors target return as their goal rather than risk. In our years as investment advisors, most individuals have come to us with an expected return in mind. Few individuals have come to us with the idea of working the other way, which means finding a level of return volatility the investor was willing to live with and living with the accompanying expected return.

In fact, few individuals have a clear idea of the concept of risk. In our experience, it seems that what investors want is an investment professional to both protect their assets on the downside and offer them the potential for gains on the upside. They may be willing to lose a little on the downside, but that loss has to be well defined. From the investment manager's perspective, our hope lies only in helping to determine what the investor's expectations are and how to define ...