Podcast 1st April 2016
Hi I am Arjun Parthasarathy speaking and this podcast is on “Risk Averse is often a misused word when it comes to investments”
Risk Averse is a word that is used for investors. What does it actually mean and is it used in the right context or used for convenience?
Risk averse means that an investor does not want to face capital losses on investments. Risk averse is usually imposed on asset classes. For example, investors who do not want equity exposure but want only fixed income exposure are termed as risk averse as fixed income is seen as less volatile than equities. However, here risk aversion leads to the high risk of not being able to meet financial goals or even investing in fixed income assets that may not return capital (credit default).
The word Global Risk Aversion is often heard when financial markets turn volatile. Risk aversion here implies that all assets of emerging markets, currencies, bonds and equities are risky assets and global investors are shunning them. However the volatility in equities, currencies and bonds of developed economies are now as high or much higher than the volatility in assets of emerging economies.
Investors term themselves risk averse and do not invest in asset classes such as equities or even government bonds and corporate bonds. Such investors do not want to face short term price fluctuations even at the high risk of forsaking longer term gains. In fact here Risk Aversion by the investor is itself a high risk strategy. For example a Risk Averse investor would be saving to buy a house and house prices could be appreciating fast in value. The investor saving in low earning assets such as Bank Fixed Deposits will definitely not be able to buy a house.
Many investors do even more foolhardy Risk Averse investments. They will shun equities, bonds, mutual funds terming them risky and then invest in schemes that promise high returns that are definitely not sustainable. Such investors lose all their savings even as they term themselves Risk Averse.
Investors become Risk Averse when markets are falling and this leads to even more pain. At bottom of equity markets, investors will end up selling equities and keep money in fixed income. They lose the upside of equities and will end up buying equities at higher levels, which could again lead to more Risk Aversion when markets turn volatile.
High income earners or high net worth individuals term themselves as risk averse and are usually under invested in equities. The same individuals will invest in exotic financial products that are more risky than equities, will invest in real estate with high leverage that is even more risky than equities and find that their low risk investments are causing them the most pain.
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