Risk: Definitions

In investment management, risk refers to the uncertainty associated with the return an investment will generate. It's the possibility that the actual return will differ from the expected return, and this difference can be positive or negative, although the negative outcomes are generally the focus.

Key Aspects of Risk:

• Uncertainty of Future Outcomes: Risk stems from the inherent unpredictability of future events that affect investment values.

• Deviation from Expected Return: The greater the potential deviation, both positive and negative, from the expected return, the higher the perceived risk.

• Probability Assessment: Risk involves assessing the probabilities of different possible outcomes. It's not just about knowing something could happen, but how likely it is.

• Quantifiable Element: While uncertainty is a broader concept, risk often implies a degree of quantifiability. We try to measure and manage risk using various statistical tools. Distinction between Risk and Uncertainty:

• Risk: Situations where the probabilities of different outcomes can be estimated or calculated (e.g., using historical data).

• Uncertainty: Situations where probabilities of outcomes are unknown or impossible to determine accurately. "Knightian Uncertainty," named after economist Frank Knight, describes situations with unknowable probabilities.

Different Perspectives on Risk:

• Downside Risk: The probability of losing money or underperforming a benchmark. This is often the primary concern for investors.

• Volatility: The degree to which an investment's price fluctuates. Higher volatility often implies higher risk, though volatility itself isn't inherently "bad."

• Systematic Risk (Market Risk): Risk inherent to the overall market that cannot be diversified away (e.g., recessions, interest rate changes).

• Unsystematic Risk (Specific Risk): Risk specific to a particular company or industry that can be reduced through diversification (e.g., a company's poor management, a product recall).