What is high risk?

What is high risk?

Photo credit: Kenny Jenkins – kbjenkins.com on Visualhunt

In the years I’ve been time advising clients I’ve come across various investment products and schemes that in their promotional material state a level of investment risk that applies to the ‘investment opportunity’.  This is often included as though it were a statement of fact with no evidence or data to back up the claim.  

We recently came across some promotional material for an unregulated investment in the medical technology sector that was aiming to attract funds from investors.  The company was in its early fund-raising stage, had an agreement in place to supply parts to another manufacturer and was in negotiations with others.  I’m not qualified to pass any judgement on the potential for this company to be successful – and it might be an excellent long term investment – but the literature stated that the investment was ‘medium’ risk.  The immediate question that came to mind was ‘If this is ‘medium’ risk, what is ‘high’ risk?’. 

For us and our clients, an investment in an unregulated start-up business would be deemed high risk, with a good chance of losing all of the money invested.  However, this, and it’s not alone – we’ve seen this many times – was being promoted as ‘medium’ risk.  This statement wasn’t backed up by any data, comparisons or further explanations, which is where the problem arises. 

Any statement about the level of risk of an investment opportunity or product is open to many interpretations by the reader.  The authors of these types of material might be making the risk statement based on other start-up investment opportunities.  In that case, low risk to them might be a large company with a guaranteed income stream and high risk might be an investment idea with very few other investors and no current avenue to sales.

However, the understanding of what the author means by medium risk is in the ‘eye of the beholder’.  They might read the ‘medium’ risk statement and think that savings accounts are low risk and equities are high risk and therefore this investment is somewhere between the two.  I’m sure that everyone coming across this type of investment would realise that there might be many other risks, but you get my point.

With collective investment funds we now have standardised ‘Key investor information documents’ that include a risk/reward profile.  These provide a number out of 7, with lower numbers indicating lower risks and lower potential rewards and higher numbers being the opposite.  Under the risk/reward profile, it states additional information.  This includes that: the indicator is based on historical data and may not be a reliable indication of the future risk profile of the fund; the risk category shown is not guaranteed and may change over time and the lowest category does not mean ‘risk free’.  

This information is limited and still doesn’t really express any details of the potential losses an investor in the fund may experience or its volatility but it does allow an investor to compare this risk/reward profile to other funds.

Statements of investment risk in products with no justification or reasoning for how the rating was derived aren’t helpful, shouldn’t be relied upon and are, one could argue, misleading.  There’s often no basis for comparison to other investments or any information on the scale used, i.e. what is low risk and what is high risk. 

If an unregulated investment in a start-up business can be described as ‘medium risk’, I would like to see what they think is high risk.  Investors beware!  Only invest in things where you understand the associated risks and have the emotional tolerance, capacity and need to accept them.  

Cheers

Charles

This blog is intended for information purposes only and no action should be taken or refrained from being taken as a consequence without consulting a suitably qualified and regulated person.  Your capital is at risk when investing.  Past performance is not a reliable indicator of future results.