Understanding is key to managing risk

Gillian Bernard

Wednesday, January 16, 2013

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The key to managing risk is to first understand the different types of risks that are associated with a certain investment and then to balance exposure based on your personal level of risk tolerance and expected returns.

Let us take for example Jamaica's current economic condition and the various risks investors may experience. One of the major risks is that of default/credit risk as it relates to the country's debt issuances. Jamaica's sizeable debt (approximately $1.7 trillion) and the inability to facilitate same, coupled with the Government's lack of strategy or solution going forward, presents a high level of uncertainty and risk for those invested. Local equity markets will also be affected as publicly traded companies are subject to high levels of inflation, the devaluing dollar, and low levels of market/investor confidence. All three factors mentioned are various types of risks - inflation, foreign-exchange and market risk respectively.

The most obvious way of mitigating these risks would be to look to International Markets in order to hedge any exposure to local markets. Researching options based on asset class, credit ratings, political risk, currency & geographic location is important in diversifying your portfolio and ultimately lowering risk.

Outside of Jamaica, the global markets present their own types of risks. The Eurozone's debt crisis, the US's fiscal challenges along with China's slowed growth and rising inflation should be factored in when making investment choices. Including "A-Grade" investments in your portfolio, such as Canadian or Brazilian sovereign bonds, will aid in lowering credit risks and the effect of market volatility. Large-cap companies with a strong history of dividend growth and performance are also safer plays as they tend to have "wide economic moats" (or benefit of economies of scale on their side). Typically these investments carry lower yields, however, they provide peace of mind ensuring return of capital versus a strong return on capital.

One may assume that in playing it safe, settling for low yields is to be expected. However, a well balanced portfolio may include investments that have higher growth potential - such as stocks or high-yielding bonds bought at the right time. Factoring in the price of an investment may help to reduce perceived risks. Buying a stock below its current book value or in the case of a bond, sufficiently below par, indicates that you are purchasing the instrument at a discount creating what Benjamin Graham coins, a "margin of safety".

While investing in hard currency may lessen foreign-exchange risks, it is important to factor in investment objectives along with local cash requirements in order to avoid liquidity risks. Short-term Jamaican dollar options such as money market instruments or Government issuances with tenures under a year (for example the 30-day Bank of Jamaica 6.25 per cent CD or treasury bills), may be considered to obtain slightly better yields than a savings account. Converting all funds or savings to USD and then having to sell in order to facilitate short-term liquidity needs may result in a loss due to the spread between prevailing buy and sell exchange rates.

For funds that one intends to keep in Jamaican currency and open to higher levels of risk, one may explore the local equity markets. The Jamaica Stock Exchange, which continues to present numerous opportunities for investors, is ideal for investors seeking higher yields (both dividends and capital gains) with lower tax implications than a typical savings account or fixed deposit. Including equities in your portfolio will assist in diminishing the impact of inflation and taxation. Choosing companies which are poised for harsh economic times, demonstrate strong growth and have low debt levels is one way of lessening risks associated with investing in equities.

One such example is Lasco Manufacturing, for which revenue in its second quarter increased by 20.53 per cent to $958.04 million. The company broke ground for a state-of-the-art factory in White Marl, St Catherine, last January. LASCO's chairman, Lascelles Chin, highlighted the future benefits of the new manufacturing facility in his statement: "It will mean a streamlining of production that will translate to increased sales and profits, and will be a stepping-stone for the continued growth of our manufacturing company."

Another junior market pick is Dolphin Cove whose profit for the its first nine months this financial year rose 26.3 per cent to $248.55 million attributable to a 17.49 per cent increase in total revenue to $1.02 billion. This was led by expansions in Dolphin Cove Attraction Revenue and Ancillary Services Revenue. The company plans to grow its operations throughout the region, having recently purchased property in Turks and Caicos.

Risk is inherent in every investment, whether it be owning a piece of land or owning a share in a company. Researching and understanding what the investment entails, and the factors that may affect it, combined with guidance from a financial advisor, will assist you to make optimal investment decisions. Should an investment choice turn out to be a dud, not to worry as the diversification of a properly balanced portfolio should hedge or buffer any serious losses. One must take calculated chances in the face of risk so as to reap the benefits because as we all know, one thing we can count on - without risk, there is no reward.

Gillian Bernard is an Advisor in the Corporate Wealth Division at Stocks & Securities Limited and can be contacted via gbernard@sslinvest.com




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