Page 103 - Profile's Unit Trusts & Collective Investments - September 2025

Investment risk Chapter 6

Chapter 6

Investment risk
NQF
Relevant to
Superior investment returns cannot be achieved without taking on risk. 119917: 1, 4
Identifying how much risk (and what kind of risk) is worth taking on is the 242594: 1 - 4
key to successful asset management. The most fabulous returns can 242612: 4
243130: 1, 4
be achieved by having all your eggs in one basket – provided you choose 243148: 2, 5
exactly the right basket. But picking the right basket is notoriously 243153: 3, 4
difficult, and for this reason diversification is a widely accepted
strategy for reducing risk. Too much diversification leads to mediocre returns,
however, and badly implemented diversification can be self-defeating.
Another basic principle of investment is to match the financial needs of the investor with the
risk/return profile of the investment. The investments appropriate to each person vary according
to the investment term, income, available capital and even the emotional resilience of the investor.
Collective investment scheme (CIS) managers have designed investment products to meet a broad
range of investment needs and objectives, and this proliferation of products creates many more
permutations along the risk/return and diversification continuum. But to understand the pitfalls and
benefits associated with different products, a general understanding of investment risk is essential.
What is risk?
There is no one definition of risk and no one answer to the problem of managing risk.
For some, “risk” is synonymous with the threat of loss. For these people an investment is risky if
there is any chance of a decrease in the value of the starting capital. Some individuals think of “risk”
as the prospect of total loss.
For others, risk is another word for unpredictability. This is closer to the formal definition of risk,
where a risky investment is one with an uncertain (but not necessarily negative) outcome.
There are even people for whom the word risk evokes excitement and opportunity.
Where risk is a fear of loss, the investment objective is often protection of capital, which
conventionally, usually means conservative low-return investments. But this approach carries
another risk: inflation risk, the risk of losing value in real terms.
Interestingly, there is a connection between education and risk appetite. As a rule, people who
have studied and understood the financial markets are more likely to accept a certain level of risk.
Paradoxically, this often leads to better returns.
The unit trust industry is rightly concerned with measuring risk and finding ways to match investors
with appropriate investments. This endeavour is complicated by shifting sands: the risks of different
asset classes are not consistent over time and the circumstances of investors are changeable.
Appropriate, conservative investment advice often condemns the investor to poor returns.
In this chapter, against the background of these difficult questions, we examine the nature of risk,
the methods used to measure risk, and the choices faced by advisers and investors.

Risk assessment
Many management companies, LISPs (platforms) and independent brokers have designed risk
assessment forms which look something like the questionnaires included in this chapter (the Risk
Profile Worksheets). Advisers use these forms to evaluate the risk appetite of their clients so that
they can match the client’s risk profile with a range of appropriate investments.
Some questionnaires focus entirely on risk appetite; others try to evaluate risk capacity as well
(the risk profile questionnaires in this chapter address both). Generally, this strategy suggests that

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