Welcome to edition number ten of our newsletter ‘Spectrum in Occitanie, Finance in Focus’, brought to you by your Occitanie team of advisers Derek Winsland, Philip Oxley and Sue Regan, with Rob Hesketh now consulting from the UK.
It seems remarkable, to me anyway, that we are already nearly a quarter of the way through the year. We still have the same problems to deal with, namely the fallout from Brexit and the continuing scourge of the Covid 19 virus, where the UK and France seem to be on diverging paths, both in terms of infections and vaccinations. With this in mind, we decided that it might be a good idea to talk today about risk, and how we might learn to live with it.
What is Risk?
Firstly, it is important to realise that risk is everywhere, and in various forms. In a sense it is like oxygen; without it, nothing happens. Sometimes you can see it, but most of the time you cannot. One thing that Covid 19 has taught us is that the very air that we breathe and the everyday items that we touch can kill us, and that is a sobering thought. The real definition of risk is the possibility that something bad might happen, either to you or because of something that you do; or even do not do. That is what makes risk exceedingly difficult to avoid. Often, we think of risk as taking a chance or a gamble, but sometimes a decision not to do something is just as risky.
Can I avoid Risk?
Yes, it is certainly possible to avoid some risks, but sometimes this has unintended consequences. If you do not eat, you cannot get food poisoning, but if you cut out that risk altogether, the end result is not positive. When it comes down to it, you have to accept risk. The real trick is calculating those risks and evaluating the likelihood of something bad happening. In investment terms, if you do not invest (and take some level of risk), you eventually run out of money. Unless of course you have a never ending and regular source of income – wouldn’t that be nice?
What is Financial Risk?
Basically, the danger of losing some or all of your money. And it comes in all shapes and sizes. There is a bewildering array of types of risk that analysts use to make them sound clever. There are however some really big ones that you need to look out for, and here are what I consider to be the most important. Have a think about how you would rate them in order of importance.
Specific and Market Risk
Here we have in fact two slightly different risks. Specific Risk is the danger of investing in one individual share, fund, or bond. If you limit yourself in this way, you put yourself at far greater risk of loss. All your eggs are in one basket. Market Risk is the danger of losing money even if you have spread out your investments more widely. Whole sectors can suddenly dip and turn against you.
You may have the best investment portfolio in the world, but what if your chosen investment company goes bust due to mismanagement, or maybe a rogue trader? Think Equitable Life, or Nick Leeson at Barings Bank.
Foreign Exchange Risk
One day we may have just one global currency. Then we will be able to forget the pitfalls of F/X risk. Until then we need to be very wary, especially we UK expatriate residents in the eurozone. In just twenty-one years the exchange rate between the pound and the euro has fluctuated between 1.75 and 1.02. That is a massive trading range. Big enough to put a huge dent in even the best investment performance. Worse still, it was not a linear move. It keeps on going up and down.
Remember 23% inflation rates in 1975? I do. Great for reducing the value of debt very quickly, but equally adept at destroying the value of savings and investments.
With all these dangers lurking at every corner, you may well be considering the mattress as a suitable home for your money. Forget it. Inflation risk will kill you, even if your house doesn’t burn down, taking the mattress and your savings with it.
The plain fact is that we all need to accept some level of risk. There is a risk/reward ratio; there is no gain without some degree of risk. The more risk you take, the more chance you have of seeing exceptional returns, but there is also more chance bad things can happen to your investment. The trick is to evaluate your true appetite for risk, and that is not as easy as it sounds. Left to his or her own devices, a single investor will tend to overestimate an appetite for risk and end up with a more aggressive portfolio than he or she feels comfortable with when a market ‘realignment’, sometimes referred to as a crash, happens a few months or years later.
The truth is that we need someone to hold our hand and lead us through this risk minefield. If we try to navigate the minefield ourselves, we are likely to lose a financial limb or two, or even worse. There are various levels of help available to us.
The most effective, in theory anyway, is the DFM, the Discretionary Fund Manager. He (or she) will sit down with you at the outset and ask you lots of clever questions which are designed to reveal your real appetite for risk (not just what you thought it was). You then pay a fee of around 1% of your portfolio each year for the DFM to invest your money for you and produce as good a return as possible without exceeding your risk pain threshold.
If you decide that you cannot afford a DFM, or maybe you have not got quite enough money for a DFM to offer his services to you, the next best thing is MAP, which stands for Multi-Asset Portfolios. They are offered by insurance companies or investment services providers. These funds are specifically designed to offer you investments that are graded for risk and ensure that your investments are spread out over many markets and sectors, thereby reducing your ‘specific’ risk. Both DFM and MAP investments can be held in what are known as ‘open architecture’ bonds within assurance vie policies in France.
Many of you will also be acquainted with the ‘closed architecture’ assurance vie offered by Prudential International. This assurance vie effectively combines the dual role of the DFM and MAP. Their PruFund range of funds is administered by Pru’s own in-house team of fund managers, and each fund is invested in a wide range of markets and sectors.
In essence then, my message is this; do not take on risk without knowing exactly what you are doing, but do not avoid investments. If you do not know exactly what you are doing, get a professional to do it for you. They are acutely aware of all kinds of risk, and how to use it proportionately. Your friendly local International Financial Adviser (that’s us by the way) is there to act as a conduit to guide you into safer investment waters.