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RISK BUDGETING
Traditional money management often ignores the fact that markets are sometimes more risky than at other times (i.e., US stock market just before the “Technology Wreck” of 2000-2001).
PŮR's risk budgeting approach (used currently only by the largest pension funds in the world but recommended for use by all others) uses volatility as an indicator to make subtle shifts in the portfolio.
Like getting into a bath tub that is too hot (risky), most people let out some hot water (reduce risk) and add some cold water (lower risk). The procedure is repeated until the resulting temperature suits the individual's preference. Conversely, when the water is too cold (low risk), hot water is added. This is what PŮR does with portfolios. We remove riskier assets when the market is volatile and add riskier assets when when volatility is less threatening. The result is money saved during risky times and more money put to work when risk is low. Of course, some like their baths hotter than others!
We match the temperature to the individual with consistency and discipline. |
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BEHAVIORAL PROFILER
Behavioral finance is the scientific attempt to study personal preferences and biases in the decision making process. An example is prospect theory that implies that most people are risk averse (i.e., they equate two dollars of gain to one dollar of loss).
PŮR uses this preferences approach to determine how investors view the pool of capital they are investing. There are three primary goals.
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Goal 1 is the portion of the funds that will be used for the basics : food, clothing and shelter. Not much risk can be taken with these funds so we treat them very conservatively.
Goal 2 is targeted for improvements in lifestyle and wealth creation. There is a little more room for risk but we are still quite cautious here.
Goal 3 is the “legacy” portion. It is that part of the capital pool with the objective of intergenerational transfer, long term philanthropy etc. The longer investing horizon allows us to take more risk than with the other two goals.
We derive a “Risk Score” that incorporates the investor’s allocation of assets to these three goals and manage portfolios strictly to this guideline. |
As with all things, goals can change. Consequently, we affirm the goals each year with each investor.
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