Investment Risk, beyond the Standard Risk Measure

If you’ve ever studied our investment options you’ll know that we include a risk label, the Standard Risk Measure (SRM)¹, when describing the attributes of an investment option.

Industry best practice is to include this to assist you in making an informed investment choice both within and across super funds. The SRM for the QSuper Ready Made and Your Choice investment options is shown below. It ranks an investment option from very low to very high risk based on how frequently a number of negative annual return are expected over a twenty-year period.

Figure 1: Standard Risk Measure ratings

Source: QSuper, Investment Choice Guide issued 1 July 2016.

However, in practice there are many aspects to investment risk and when we devise investment strategies for our multi-asset class investment options we aim to consider these through our modelling. For example:

• if there was a negative annual return, how large might it be?
• what are the chances of a strategy giving good returns over the long-run?
• what would happen if inflation increased?
• are we too concentrated in a particular country, industry or company?

While the SRM shows how frequently negative annual returns may occur, this post takes a look at broader investment risk and the modelling of how severe an investment loss could be when there is a market disruption impacting several investment options.  

To gauge the severity of loss and as input to our modelling, we consider the maximum loss arising from risk events from recent history. This is known as a ‘drawdown’ - it measures movements in the relevant option’s unit price from peak to trough. In periods of positive annual returns, a zero is recorded.

Regular readers of this blog will know that in 2011, we made some changes to the investment strategy of the Balanced investment option. In the example that follows, we model the impacts of historical, negative market events on the Balanced option for both the pre-2011 (‘old’) and post-2011 (‘new’) portfolio.

Based on historical drawdowns, our modelling below suggests it is likely smaller losses would have occurred through the ‘new’ strategy in many disruptive market events. However, our analysis did show there are two exceptions from history where this is not the case: the 1994 Bond Shock and the Oil Price Shock in the 1970s (see Figure 2).

Figure 2: Portfolio drawdowns – old and new Balanced investment option strategies

Past performance is not a reliable indicator of future performance. These are simulated returns based on internal modelling. Simulated New Balanced investment option outcomes were determined based on historical annual returns and current strategic asset allocations. Old Balanced investment option uses historical returns and 2010 asset allocations.

So our modelling has shown the new investment strategies will not necessarily outperform the old strategy in all market conditions. However, this modelling further revealed that performance under these two events (1994 Bond Shock and the Oil Crisis in the 1970s) was not materially worse for the new strategy. Given these modelling outcomes and consistent with our longer term investment approach, we are prepared to accept these risks in exchange for what we expect to be greater protection in periods where share markets perform poorly.  

1. The Standard Risk Measure is based on industry guidance to allow members to compare investment options that are expected to deliver a similar number of negative annual returns over any 20 year period. The Standard Risk Measure is not a complete assessment of all forms of investment risk, for instance it does not detail what the size of a negative return could be or the potential for a positive return to be less than a member may require to meet their objectives. Further, it does not take into account the impact of administration fees and tax on the likelihood of a negative return. Members should still ensure they are comfortable with the risks and potential losses associated with their chosen investment option/s. Please refer to our Investment Choice Guide for more details.

The views of the author and those who provide the responses to the comments posted on this blog are not necessarily the views of the QSuper Board. We’ve put this information together as general information only and you should get professional advice before relying on this information. Past performance is not a reliable indicator of future performance. Each of our investment options has a different objective, risk profile, and asset allocation.