- Two people jump out of a plane, flying high above the ocean. One is wearing a parachute, one is not. Which person is at greater risk of death? The answer is deceptively simple: the person with the parachute is most at risk. The fate of the person without the parachute is certain so there is no risk. Risk requires uncertainty.
- A potato walks into a chip shop. What risk is the potato exposed to? Again, the answer is that the potato is not exposed to any risk, even if it is turned into chips, because a potato doesn’t have a plan for the future (it’s only a walking potato).
These two riddles show that risk requires uncertainty, and that we care about the outcome.
A recent article by Oxford Risk makes this point, albeit in a more serious way. It says that risk is not about the journey, but where we could end up. On the other hand, volatility is only about the journey and never about the destination.
The same is true of investing except that most client profiling assumes we will have a single risk appetite. We find that charities most often have at least two at any one time – what we need for the near future (say within five years), and what we need to the longer term (more than five years).
In the near term we expect to have the cash available when we need it to meet our obligations, and in order to achieve that we must sacrifice returns. Paying our bills is our goal. Over the long-term, charities can vary their priorities and – unlike pension funds – can flex their future liabilities. This means that they can take more risk and potentially earn more for their beneficiaries.
The matrix below reflects the relationship between what are regarded as ‘safe’ and ‘dangerous’ investments, and our time frame. For a long term investor traditionally ‘safe assets’ can be dangerous (because of inflation) and vice versa. When thinking about risk we need to be completely clear about our time frames, and recognise that our investment approach will differ in each case. ‘Medium risk’ becomes remarkably uninformative.
What is harder for charity Trustees is to find a manager who will adjust the balance between the short- and long-term assets as these priorities change. Too often the ‘medium risk’ label is misapplied in the first place, and then is rarely revisited, making it more likely that this single risk appetite fails to reflect accurately the charity’s needs.
To address this, one of the key services we offer at Yoke is to work with Trustees to understand, assess and manage risk; read more about our approach, including some recent case-studies.