Successful investment management is about effective risk management. In this post we explore the concept of 'Market Risk'.
So you have accumulated enough cash to have a safety net for when things go wrong. Or perhaps you have come into some funds you were not expecting. Wherever you are in the cycle of growing your wealth, understanding risk is critically important.
This series will cover some of the critical risks for consideration before making any investment. I am going to start with one of the most prominent and arguably straightforward – Market Risk.
A suggested definition for this would be:
“The possibility of an investor suffering losses due to the external factors that have an indiscriminate impact on global stock markets."
The current pandemic is an excellent example of an event with wide-reaching implications for countries and economies worldwide. Initially, it resulted in sharp falls across global stock markets such as in March 2020 when the FTSE All-Share Index fell by 15.07%. Fortunately, we have since seen a recovery, but recent and long-term investors will likely have experienced some fall in the value of their investments.
Other examples of issues that can drive Market Risk are political turmoil, war, natural disasters and terrorist attacks. Another case from recent memory is the 2008 financial crisis, where the calendar- year performance for the FTSE All-Share was -29.93%.
Government policy change and, indeed, a change of government, can also precipitate significant market reactions. 1990 saw the British Government joining the ill-fated ERM (European Exchange Rate Mechanism), which resulted in the value of the pound falling dramatically until the crash of 16th September 1992, better known as ‘Black Wednesday’.
Investment managers cannot wholly mitigate events of this nature with proven risk management techniques, such as diversification (more on that in a future piece). This is because their impact is indiscriminate, meaning the value of all asset types are typically affected.
Thankfully, history tells us that the impact of these crashes is temporary. Markets usually recover, but the question for investors is how long will they take to do so and what does that mean for their investment time horizon? Market Risk and the other risks associated with investing, are why all good professionals recommend only investing for the medium- to long-term. Investing for the short-term is really just speculation.
Good investment discipline can help mitigate the scale of the short-term losses associated with Market Risk, but investment managers cannot eradicate them entirely. Having a professional investment manager overseeing your money in times of turmoil, undertaking what the industry describes as 'active management', is for many investors preferable to investing in assets which simply replicate the market performance. It is also something those contemplating making their own investment decisions should consider: do they trust themselves to make the right decisions in times of severe market stress?
The contents of this article are for information purposes only and do not constitute advice or a personal recommendation. Investors are advised to seek professional advice before entering into any investment decisions. Please also note the value of investments and the income you get from them may fall as well as rise and there is no certainty that you will get back the amount of your original investment. You should also be aware that past performance may not be a reliable guide to future. performance.