“Subra it is all well that you taught us Standard deviation, Sharpe Ratio, Treynor Ratio….and how to read a fact sheet, but which is THE measure of risk that I should use to invest my money and my client’s money”

I was asked this question at the end of a ‘How to read a fact sheet’ class. Not sure how many sales people will read the fact sheet, but trainers need topics, right?

As usual I did not answer this question. Instead I said….

The risk is not in the paper in front of you, but in your head. You need to understand that standard deviation – from the mean of the fund or from the benchmark is just a past measure and is not very useful for the future. That is an important lesson.

Far more important is how will you react to poor performance of your fund.

Lets take an example. You and your clients had a great 2008 to 2018 decade and you got a 13% cagr in fund A. Let us assume that the standard deviation too was low, but hey you never bothered about that, did you?

Now you and your clients think (thought) that fund A is PPF on steroids and it is the fastest way of reaching your targets. After all 13% cagr over 10 years can do wonders to your portfolio, can it not? Sure 27 can do better, but you are smart enough not to crib about 13%.

Let us say a lot of this return was back ended and the year 2017 and 2018  gave 15 and 19% return. Your clients who came to you in 2016 think very highly of you and YOU are now confident about this fund. You have now started touting about this fund to all and sundry and about 25% of your aum is in this fund. Great show.

Your client Mrs. S a retired school teacher put Rs. 100,000 in this fund in 2018 Jan and has seen it perform well in the past 5 months. You show her the statement and both of you are happy.

In 2019 the fund was a disaster. It wiped out Mrs. S’s gains and she saw her portfolio fall (plummet is the word she used) and go to Rs. 89,000. She was devastated. In 2020 it did NOTHING. The value of the fund was 87000. Mrs. S a reader of 2 newspapers saw that the fund that YOU had touted as a great fund also held shares of Manpasand, and a couple of other shares (shady accounting practices)…so she removed her money in Dec 2019 and she got Rs. 84,000 after all deductions. The pink paper that she reads also told her that if she had kept it in a bank FD she would have had at least Rs. 118,000. What a loss. ALL BECAUSE YOU recommended a wrong fund. After all, the market did not do too badly.

Mr. A had also invested in the same fund and he came to you in 2021 and was THRILLED with the 34% return that he got in 2021 in that fund and his over all 16% cagr over a 14 year period. He was all praise for your fund picking skills.

See what happened? the standard deviation, the beta, the Treynor, Sharp ratios….all remained the same for both the investor. The risk was in the head of the IFA and the investor.

The IFA did not understand that he did not understand risk! The client and the IFA did not understand how the client will behave when risk actually hits. Mrs. S used to read the newspaper every day and get panic attacks. Mr. A was a businessman who looked at his portfolio once in a while – and understood how to handle standard deviation.

If the IFA (read you) are modest about ‘your skill’ in picking the right fund, do asset allocation, understand client psychology, you have understood risk.

However, risk is not in how the market behaves or what the deviation numbers are. Risk is how you behave when standard deviation strikes..