‘Investments that are riskier than you think’

In the world of investments, there are different definitions of this element depending on the instrument you are dealing with and your personal propensity to deal with it. To use a general definition, it can be said that, when investing, risk is the possibility that the return is worse than expected, leading to the loss, in part or in whole, of the value of the investment.

Making a list of assets considered risky is just as difficult as defining risk itself. However, there are some instruments that are increasingly entering investors’ portfolios that carry risks that perhaps not everyone is aware of, cryptocurrencies and so-called meme stocks are some of the most popular risky assets of the moments.

Bonds issued by sovereign states are denominated either in local currency or that of a developed market (hard currency, usually US dollar).

This creates two distinct subsectors within emerging market bonds and exchange rate risk is the dividing line that investors should keep in mind between the two. “Currency fluctuations, for example, are the main performance driver for the local currency market,” says Neal Kosciulek, manager research analyst for Morningstar Research Services.

Country Tracker Funds

“Interest in-country funds (also known as country tracker funds) always worries us,” says William Samuel Rocco, senior manager research analyst for Morningstar. “They are often used to follow countries that, at a given moment, are considered hot. And this is always a dangerous attitude. We have found that investors don’t always perceive how risky they can be or how to use them properly”.

Worth noting is that focusing on a specific country does not always guarantee real exposure to that area. This can be seen by looking at the revenue exposure (where companies make their profits) of the securities that are part of a given basket. An investor who buys a UK small-cap equity fund, for example, is actually investing in companies whose fortunes depend in part (almost 20%, on average) on the business they produce in the United States.

Small Caps

Small caps stocks can tend to offer higher long-term returns because they are coming from a lower base, but investors need to be prepared to withstand phases of considerable volatility.

These companies are less-known to the market, which means there is a greater opportunity for some active managers to make good choices within the sector and outperform an index. But, along with better growth prospects, there is also a chance of seeing setbacks.

In general, small-caps can offer a better alignment of interests between investors and the board of directors of a company (which often coincides with the family that founded the company) which, even when things go wrong, does not abandon ship. “Small-cap stocks are generally more volatile than their larger counterparts and should have their place in a well-diversified portfolio,” says Alex Bryan, analyst for Morningstar.

Risk to take and your capacity

So, how much risk should an investor take when investing? Investors can determine their risk levels using three steps. However, your risk capacity helps you understand the optimal amount of risk you could take in order to maximise the chance that you reach your goal, depending on how far you are from that goal. If you’re further away, you can handle the risk that your portfolio loses money for short periods.