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Understanding Risk
There are many ways that the investment
industry uses the word risk . Webster's Dictionary
defines risk as
1. "The possibility of suffering harm
or loss" and
2. "The variability of returns from an investment."
These two common definitions of risk
may be applied to either individual securities or to
a whole portfolio.
One of the driving reasons for the founding
of Spectrum Financial, Inc. was to provide investment management
services that would help minimize the severe loss of capital
that is experienced during long-term market declines, commonly
called Bear Markets.
The decline in portfolio value experienced
during Bear Markets is referred to as a Draw Down. While
the phrase "Draw Down" doesn't sound too bad, the fact is
that Bear Market Draw Downs can be 30-50% of a portfolio's
value.
Spectrum has developed a number of actively
managed investment Strategies that, especially when used
together, have historically been effective at generating
attractive returns while minimizing the magnitude of losses
experienced by those who make few or no portfolio adjustments
in a Bear Market. Naturally, past performance cannot be
considered indicative of future returns, but without some
means of risk management, portfolios are vulnerable to the
worst a Bear Market can do.
As for the variability of returns; we
look at risk almost exclusively from a portfolio
perspective rather than on an individual security basis.
There are two important reasons for this. First, we use
mutual funds that are relatively broadly diversified so
the risk of loss to the portfolio from any one security
in the mutual fund tends to be minimal. Second, to add further
diversification, we recommend that each client has a portfolio
that utilizes more than one of our actively managed investment
Strategies. If diversification among Strategies is not possible
due to the amount of capital, Spectrum recommends one of
our low volatility Strategies.
When the industry compares risk
to the variability of returns they are referring to
the volatility that is experienced with a particular security
or a particular portfolio. Many people in the investment
industry believe volatility risk should be avoided
except for the most aggressive investors. Spectrum believes
that volatility should be controlled by actively managing
portfolios to move out of holdings that are experiencing
downside volatility that is reducing returns while using
upside volatility to enhance returns. In other words, in
our pursuit of attractive returns, we use volatility to
enhance our returns and use our strategies to control that
volatility.
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Strategies that hold only one
fund when invested are considered as having more
risk than strategies that hold multiple fund positions
when invested. |
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Strategies that are 100% invested
when they are invested are considered as having
more risk than strategies that may have varying
degrees invested positions. |
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Strategies that use more volatile
funds, including enhanced beta funds, are considered
as having more risk than strategies that use low
volatility Funds. |
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Strategies that use short funds
for purposes of taking an outright short position
are considered as having more risk than those that
do not use such funds for going short. |
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Strategies that tend to be invested
for longer time frames are considered as having
more risk than those that are only invested for
a short period of time when invested. |
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Strategies that borrow money
to purchase funds on margin are considered as having
more risk than those that do not use margin.
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No one of these criteria is meant to be
used alone in determining the risk of a portfolio. But together
they can provide a useful guide in determining the overall
risk associated with a portfolio made up of Spectrum strategies.
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