OPINION: Professional investors consider “risk” to mean “volatility”, which is how much share prices gyrate up and down. Many other investors consider “risk” to mean loss of capital, which is the likelihood of an investment not returning your money.
Whether it means volatility or loss to you, assessing risk is key to an effective investment strategy. With 2020 moving to an end it’s time to understand changing investment risks for 2021.
We can group many risks into three high-level categories, being economic risks, geopolitical risks and global health risks.
Firstly, economic risks have a direct impact on company performance and share prices. China is alone right now delivering some economic growth, while the US economy could shrink 6 per cent this year. A prolonged global recession hurts equity returns through lower company revenues, capital spending cuts and stressed balance sheets. The worst case is the global health crisis morphs into a serious challenge for the global financial system, but there’s a good prospect of avoiding that outcome.
Other economic risks spring from imbalances with artificially low interest rates. Trillions of dollars of bonds globally trade at negative interest rates and 10-year US government treasury rates are the lowest in over 200 years. There is always the risk that low rates feed higher inflation which becomes difficult for governments and central banks to control.
The second category for your 2021 risk radar is geopolitical risk. We will soon know the result of the US election. There is a real risk, especially from a close election, of challenges in the courts and tensions on the streets, which would unsettle markets. By contrast, a clear Democrat victory is likely positive as it brings political certainty and hopes for a large stimulus package.
There are many geopolitical risks on top of US politics to be wary of. Resolution has not been reached with North Korea or Iran. Tensions around Taiwan, the South China Sea and the US/China trade war are not easing. Any of these could very quickly derail international investor confidence.
The third risk, which really hit the radar in 2020, is global health risk. More specifically this is the timing of an effective Covid-19 vaccine or treatment, with hopes pinned on the first quarter of 2021.
But a vaccine is unlikely to be a silver bullet. We will need to consider how effective it is (bear in mind FDA approval requires at least 50 per cent effectiveness), how easy it is to mass-produce if there are distribution challenges (for example it needs to be stored at very low temperatures) and whether one or two doses are required.
A worrying trend with vaccine distribution is the expected uptake in each country. Surveys in the US show up to half the population may not freely take a vaccine, which is both astonishing and worrying.
Of course, there are plenty of other risks outside the three categories here of economic, geopolitical and health risks. For example, climate risks are having unprecedented impacts on some regions and breakthrough technologies continue to significantly disrupt some industries.
The wide range of risks, complexity of investing globally and exceptionally low-interest rates all point to the benefits of professional financial advice. While 2020 is far from over, it’s time to also focus on your investment strategy for 2021.
John Berry is chief executive at Pathfinder Asset Management, and KiwiSaver provider CareSaver. His views in this article are general only and are not recommendations for any particular person in relation to any share or financial product.