Welcome to the November 2024 Manager’s Perspective! Each month, where relevant, InvestNow will ask our investment managers some questions surrounding our theme of the month. This month we asked India Avenue and Generate some questions to help you better understand their investment styles, strategies, and perspectives on risk. Read the questions and their responses below.

Q1: How should investors view their relationship with risk? Is all risk ‘bad’ and something to be minimised or is it something investors should embrace?

The definition of risk is driven by each individual’s tolerance and appetite. Typically, in our textbooks at school and university we have learned that risk is defined by something called standard deviation. This measure essentially measures variability of outcomes – this is a measure of how variable the final outcome could be and how different it might be to the expected outcome.

Other measures may consider risk of capital loss or risk of downside. This refers to the chance of an outcome below our expectations and/or loss of wealth. This might be considered more appropriate as investors are generally happy with outcomes above average or above their expectations.

Depending on how you perceive risk as an individual, your relationship with it will differ. Perhaps a 25-year old perceives risk differently to a 65-year old, as the chance of recovery from a “bad” outcome might be higher due to a longer potential investment horizon. However, existing wealth and risk tolerance of the investor are also important factors, aside from age / investment horizon. Someone with more wealth may be willing to tolerate capital losses and volatility of outcome in the quest for greater upside in their investment returns.

We can therefore summarise by saying that all risk may not be bad, depending on your own interpretation of what is “risky”. This will depend on your individual circumstances and cannot be categorised into “one size fits all”. If you think standard deviation is a conventional measure which helps individuals assess how variable an outcome is, then remember upside risk is not as bad as downside risk. However, upside risk may also provide an indication that there could be equivalent downside risk at some stage in your investment horizon.
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Q2: Can you describe your approach to managing risk and how this is balanced against achieving the investment objectives for your funds?

One of the best ways to reduce the variability of outcomes is through diversification. Diversification can be understood using the term “don’t put all your eggs in one basket”. To further understand this, an investor may have an extremely positive view on an investment but may not have considered the downside potential or risk of capital loss, if something were to go against their investment thesis.

Diversification allows you to reduce the variability of outcomes by reducing the risk that your thesis might be wrong. You do this by increasing the number of your investments which may reduce your upside but should also reduce the downside potential or risk of capital loss of a stand-alone investment.

IAIM manages an equity fund, which holds 60-70 listed companies in India as part of its overall portfolio. Our objective is for the fund to outperform, over rolling 5-year horizons, our benchmark, the MSCI India. Our benchmark is constructed by MSCI, weighting the top 150 companies (approximately) by their size / market capitalisation in India. An investor may ask, why not just hold one or a couple of stocks, which have a high chance of outperforming the combination of 150 companies in aggregate?

When it comes to risk it can always be answered with – what happens if your investment thesis is wrong? Diversification can reduce the impact by spreading risk across many investments.

As a fund manager, we want to provide our investors with exposure to India’s growth story, which is being driven by the country’s sizeable, youthful, and aspirant population. However, attempting to do this by investing in only in one, two or only a few companies can introduce significant individual company risk / “bad” outcomes, which then makes the chance of achieving our investment objective more variable or “risky”. Over rolling 5-year periods, we seek to increase the chance of our portfolio of companies (60-70) outperforming as a group through diversification, relative to our benchmark.

Therefore, you could say we aspire to providing our investors with exposure to the India growth story, whilst managing risks of individual companies in the portfolio being impacted by their own downfalls, rather than the overall economic story playing out.

Q3: What would you say are the 3 biggest risks that investors face going forward?

In general, the biggest risk an investor faces is not achieving their investment goals over their investment horizon. As discussed earlier this is driven by individual circumstances and should be discussed with a financial adviser prior to making investments.

It is our view that most investors fear the loss of capital in their investment portfolios. However, diversification can mitigate the quantum of losses, given appropriate portfolio construction. By this we mean that the combination of different asset classes, measured in different currencies and diversified by company and or issuer can provide a more robust set of outcomes.

Investors often consider risk and variability of outcomes of the assets they invest in individually. However, the more robust approach is to consider the potential of your entire portfolio after you have carefully diversified your range of outcomes (after discussion with your financial advisor).

Today some of the risks facing investors include:

1. Geopolitical risks and tensions appear to be increasing in their presence and headlines. Events recently in Europe, Middle East and shifts in political and religious regimes are making investors increasingly nervous and therefore affecting their sentiment and perhaps risk tolerance, when it comes to assessing the range of outcomes.
2. Equity market valuations in general are higher than they have been over the last decade. This has been driven by liquidity injected by Central Banks into Government, Corporate and Household hands since the Global Financial Crisis and the Covid-19 pandemic. This has kept interest rates relatively low and made money available more readily, which has found its way into asset classes like equity markets.
3. A sustained period of lower interest rates has led to all asset classes which rely on higher returns (than holding cash) to increase in valuation as investors seek a higher return. This period started coming to an end in 2022, with rising inflationary globally. We are unsure how this plays out in the future, which may affect the sentiment around investing in and the volatility of “riskier” asset classes.

In our view, one of the ways to counter these risks that we perceive is to diversify portfolios to reduce the variability of outcomes against investment objectives. The idea being that there is a higher chance of achieving your objective, not just hoping, or targeting achieving the best outcome possible.

This article has been prepared by India Avenue Investment Management Pty Ltd (IAIM). The information is intended to be for general guidance only and personalised to you. It does not consider your particular financial situation or goals and therefore is not financial advice or a recommendation. The opinions expressed in the presentation are the those of IAIM and may change without notice. They are not intended to provide or convey any guarantees as to the future performance of our investment products, and asset classes or capital markets. Past performance is no guarantee of future performance. Before making any investment decision, you should refer to the Product Disclosure Statement or consult an appropriately qualified financial adviser.

Q1: How should investors view their relationship with risk? Is all risk ‘bad’ and something to be minimised or is it something investors should embrace?

Managing risk is part of investing. Rather than being something to be ‘minimised’ versus ‘embraced’, we’d say it’s something to be well-managed.
This can be managed wisely through informed decisions, diversification and the right timeframe.

Growth funds will carry more ‘risk’ than conservative funds, but when you’re investing over the long term, and most Kiwis are when it comes to retirement, the risk from the ups and downs of the market is minimised, and the returns could have the greatest potential.

Time is your best friend here – you can ride out periods when the markets are down and be well-positioned when they recover. Generally, the more time you have in the market, the more risk you can comfortably take.

Q2: Can you describe your approach to managing risk and how this is balanced against achieving the investment objectives for your funds?

At Generate, risk management is a key focus – it ranks right up there with returns.

We’re active managers. We believe that doing the mahi and looking for investments with the best potential is a better approach.

Our investment professionals don’t have crystal balls and so will not always get these investment selections 100% right. This is why risk management is important – it’s all about diversification. That means we use a variety of investment approaches from many different investment professionals, spread across many different asset classes to minimise risk.

Q3: What would you say are the 3 biggest risks that investors face going forward?

Three big risks that investors face are making decisions based on market volatility, reducing contribution rates and choosing the wrong fund type.

1. Making decisions based on market volatility
   From election results to a pandemic, unforeseen events can always pop up and cause market volatility. It’s common for investors to have a kneejerk response and feel tempted to adjust their investments, for example, by switching from an aggressive fund to a conservative fund.

   However, it’s important to always keep in mind that short-term market volatility is normal and doesn’t necessarily reflect long-term trends.

   We recommend that investors with a long-term investment horizon stay in their current fund and maintain their investment strategy, regardless of volatility.

2. Reducing contribution rates:
   Many Kiwis are struggling with the cost of living right now, and some may decide to reduce their KiwiSaver contribution rate, or even opt out completely.

   In severe circumstances this might be necessary, but we always advise investors to continue contributing if possible.

   The power of compounding returns, even small amounts invested make a big difference in the long run.

3. Choosing the wrong fund type
   Growth funds offer the highest potential for returns over the long term. Approximately 83% of Generate members are in growth funds, compared to just 47%* for KiwiSaver members as a whole.

   The reason more of our members are in growth funds is because the majority of them have met with an adviser and talked through their goals, risk tolerance, and investment timeframe – which is often a longer time frame because it’s for retirement. For those with a shorter time frame, such as buying a house in a few years, the recommended fund will be different. Speaking with an adviser gives valuable guidance and peace of mind.

   For those investors who want to do it themselves without talking to an adviser, we recommend thorough research on key investment principles. We also have tools on our website that guides people through their risk tolerance and investment timeframe to decide on their preferred fund type.

* KiwiSaver Demographic Study Melville Jessup Weaver February 2024

No part of this article is intended as financial advice; it is intended as general information only. To see our Financial Advice Disclosure Statement, please see Generate FAP Disclosure Statement. For more information about the Generate Scheme’s see the Generate KiwiSaver Scheme Product Disclosure Statement and the Generate Unit Trust Scheme (Managed Funds) Product Disclosure Statement or the fund updates. The issuer of both schemes is Generate Investment Management Limited. Past performance is not indicative of future performance.

Disclaimer

The following commentaries represent only the opinions of the authors. Any views expressed are provided for information purposes only and should not be construed in any way as an offer, an endorsement or inducement to invest. All material presented is believed to be reliable but we cannot attest to its accuracy. Opinions expressed in these reports may change without prior notice.

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