Where does the risk come from in your portfolio?

Risk budgeting helps investors understand how their portfolio may react in difficult times, says Leith Wheeler's Perry Teperson.

Michael Ryval 13 August, 2015 | 5:00PM
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The manner in which money is distributed across asset classes in your portfolio is often called capital budgeting and focuses mainly on returns. Yet according to Perry Teperson, vice-president at Vancouver-based Leith Wheeler Investment Counsel Ltd., you should consider another perspective known as risk budgeting.

"You want to understand where the risk is coming from in your portfolio and understand what impact it might have, typically during a stressed or difficult time when risk is more of a concern than return," says Teperson, who joined Leith Wheeler in 2004 after 13 years as an actuary and investment consultant. "The total risk of a capital loss is usually the most pressing risk for a retail investor, so you want to know where that risk is coming from. Are the asset classes contributing equally, or is one contributing more than the other? You want to ask, 'How can that impact my portfolio if there is a difficult period?'"

Teperson argues that, generally speaking, investors are more focused on the return question. "They tend to think, 'How do I build a portfolio so that I get a particular rate of return?' But people have taken their eyes off the risk question because we've had enough time since the 2008 financial crisis," says Teperson, a South African native who earned a bachelor of business science at the University of Cape Town. "And we are in an environment of such low returns within defensive assets such as money market funds and bonds. Because of that, investors are naturally gravitating more to equities. They're thinking, 'How much more do I put into equities or other riskier asset classes so that I can meet my targeted return?'"

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Michael Ryval

Michael Ryval  Michael Ryval, a regular contributor to Morningstar, is a Toronto-based freelance writer who specializes in business and investing.

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