Investment theory and historical capital market return data suggest that, over long periods of time, there is a relationship between the level of risk assumed and the level of return that can be expected in an investment programme. In general, higher risk (e.g. volatility of return) is associated with higher return.

It is helpful to consider this concept in terms of two different risk types:

• Market risk is the inevitable risk arising from investing in volatile markets with their constantly changing prices.
• Diversifiable risk reflects the risk involved with the purchase of an individual share or a common group of shares such as forestry or retailing stocks. This is the volatility that is specific to that particular sector or issue.

Diversifiable risk can be virtually eliminated through the process of investing across the market in the full range of market sectors. On the whole, markets are efficient, and the investor is not likely to be rewarded for taking individual share risk or share group risk over the long term.

Because markets are inherently volatile, market risk cannot be eliminated, but it can be controlled. The primary objective of professional investment management is the control and management of market risk. A very wide range of potential returns can be experienced in any one year in a portfolio containing equities, but this range becomes narrower as the time period of investment increases.

Given this relationship between risk and return, a fundamental step in determining the investment policy for the Portfolio is the determination of an appropriate risk tolerance. There are two primary factors that affect the investor’s risk tolerance:
• Financial ability to accept risk within the investment programme, and:
• Willingness to accept return volatility.

Axiome outsource the objective measurement of client risk to the specialist group FinaMetrica Ltd. They are internationally recognised in the field of behavioural finance and provide a scientifically validated methodology in risk assessment, together with tools for linking client responses to portfolio performance research.

Axiome Consultants provides a free risk assessment to qualifying New Zealand investors.  Click here