By Eli Butnaru To view original article click here.
It’s time for individual investors and industry practitioners to move away from performance-based investing and begin considering risk management a key objective. This type of thinking is not mainstream but it’s fundamental to ensuring consistent success.
The typical investment fact sheet, for example, focuses on performance and volatility but doesn’t mention risk. However, few in the industry challenge the notion that capital preservation is the best path to wealth accumulation. Although timing and luck may provide outsized returns during short periods of time, it is very difficult to consistently generate large positive returns from high risk. Managing for risk in investment portfolios tends to generate performance, but the same cannot be said of managing for performance.
During fat-tail events, commonly referred to as “rare occurrences,” investors undergo large capital losses. There’s no shortage of good reasons to find better ways to create wealth, including everything from the time wasted in recovery to the emotional pain associated with wealth attrition.
The problem with fat-tails is that these so-called “rare occurrences” are really not so rare. They tend to recur, and they did recur during the 1990-2000 period. The key takeaways from these are clear:
Higher risk does not generate consistent higher returns. Timing and luck may have more to do with high returns than consistency and management skill.
Risk is not proportional to returns, which runs counter to the hope of accumulating wealth.
There are many great sources available that can help us frame the discussion of risk-adjusted performance. The most useful statistics, to name a few, include: Omega, K-Ratio, Pain Index, and Calmar.
These statistics are often used to compare managers within their peer universe and rank to consistently obtain top risk-adjusted performers.
To ensure success and generate consistent returns over time, it’s critical to evolve the way investments are viewed.
Eli Butnaru is CEO of Mora Wealth Management USA, a global provider of financial investment solutions in Miami.