Risk-adjusted returns in practice - UBS guest lecturer

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En provenance du cours de University of Geneva

Understanding Financial Markets

1925 notes

University of Geneva

Understanding Financial Markets

1925 notes

Cours 1 sur 5 dans Specialization Investment Management

In this course, you will learn what the main financial markets and their characteristics are as well as how they are linked to the economy. Our very diversified team of experts will start by teaching you how the price of stocks and bonds are computed and why they move while you will become increasingly aware of the notion of risk and why it matters when measuring an investment's performance. The focus will then move to less popular markets such as gold, emerging markets, real estate, hedge funds and private markets. These will be analyzed with an emphasis on their particular risks and return opportunities as well as how they can help in building efficient portfolios. Finally, the policies of central banks and their impact on financial markets will be presented to you along with the link between the economy and the price of financial assets. All along these different steps, experts from UBS, our corporate partner, will show you how the concepts you just acquired are effectively applied in a leading global bank. This focus on practicality means you will not only understand what is going on in global financial markets but also start to figure out how you can use them to achieve financial goals, be it a client's or your own.

À partir de la leçon

Major Financial Markets

Risk-adjusted returns in practice - UBS guest lecturer4:21

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University of Geneva- Ines Chaieb
SFI Associate Professor of Finance
Geneva Finance Research Institute
University of Geneva- Jonas Demaurex
Teaching Assistant
Geneva Finance Research Institute
University of Geneva- Rajna Gibson Brandon
SFI Senior Chaired Professor of Finance and Managing Director of the GFRI
Geneva Finance Research Institute
University of Geneva- Michel Girardin
Lecturer in Macro-Finance - Project Leader for the "Investment Management" specialization
Geneva Finance Research Institute
University of Geneva- Martin Hoesli
Professor of Real estate investments
Geneva Finance Research Institute
University of Geneva- Olivier Scaillet
SFI Senior Chaired Professor of Finance and Vice-dean (research) at GSEM
Geneva Finance Research Institute
University of Geneva- Philip Valta
SFI Assistant Professor of Finance
Geneva Finance Research Institute
Dirk Effenberger
UBS Guest Lecturer, Head CIO Cross-Regional Investment Office
Chief Investment Office, UBS Wealth Management
Mark Haefele
UBS Guest Lecturer, Global Chief Investment Officer
Wealth Management and Wealth Management Americas
Brian Nick
UBS Guest Lecturer, Strategist
Chief Investment Office, UBS Wealth Management Americas
Mike Ryan
UBS Guest Lecturer, Chief Investment Strategist
Chief Investment Office, UBS Wealth Management Americas
Simon Smiles
UBS Guest Lecturer, Chief Investment Officer UHNW
Chief Investment Office, UBS Wealth Management
Themis Themistocleous
UBS Guest Lecturer, Head European Investment Office
Chief Investment Office, UBS Wealth Management
Thomas Wacker
UBS Guest Lecturer, Head CIO Credit
Chief Investment Office, UBS Wealth Management
Chris Wright
UBS Guest Lecturer, Cross-Asset Strategist
Chief Investment Office, UBS Wealth Management
University of Geneva- Tony Berrada
SFI Associate Professor of Finance
Geneva Finance Research Institute

[MUSIC]

Hello.

I'm Brian Nick,

a strategist in our Chief Investment Office at UBS Wealth Management Americas.

Today I would like to talk to you about a concept I worked with everyday,

risk-adjusted return If you've watched my colleagues in prior videos you're

familiar with a few different definitions of risk.

To recap quickly the most common measure of risk in investing is standard

deviation.

Standard deviation tells us the range of terms in which investors can expect about

two thirds of observed returns to fall.

We say asset classes are risky when they have higher standard deviation.

And we expect those asset classes to deliver higher returns on average

than others that may have little to no market risk.

That brings us to the concept of risk adjusted return,

which allows us to compares apples to oranges in a sense.

By adjusting either historical or expected return on an asset class for

a degree of risk, we can compare, for instance, US treasuries,

to US equities when deciding how to invest.

If we were to invest solely based on maximizing return,

we would probably prefer US equities almost all the time.

But if our goal was to minimize risk, US treasuries seem the more prudent choice.

Risk-adjusted return allows us to combine these concepts, and

there are many ways to measure it.

Today I'll summarize just one example, the Sharpe ratio.

The Sharpe ratio measures units of expected excess return per

unit of volatility.

Excess return is simply the return we've received or expect to receive over and

above the risk free rate.

These days in most parts of the world this calculation is quite easy

because risk free rates are close to zero.

A high Sharpe ratio indicates a high risk adjusted return,

while a low Sharpe ratio indicates a low risk adjusted return.

I'll demonstrate how the calculation works by using the two asset

classes I mentioned earlier.

Let's say that US treasuries had given us a return of 3% with

a volatility of 5% while the risk free rate was 1%.

That would make the Sharpe ration 0.4- 2% divided by 5%.

Now let's say that US equities returned 14% with a volatility of 10%,

similar to their return in 2014.

That would give us a Sharpe ratio of 1.3, 13% divided by 10%.

1.3 beats 0.4.

In this example, equities have delivered a far superior risk adjusted return.

If only that were always the case, our job would be easy.

So why do risk of asset return matter?

Why wouldn't an investor prefer a return maximizing portfolio with 100% in

risky assets?

After all over time master strategy is performed very well.

But problem with this is most of us now is that very volatile investment strategies

are often difficult for investors to stick with when times get tough.

So including other asset classes with positive sharp ratios but

lower expected returns is optimal for nearly all investors.

By doing this we sacrifice higher returns for higher risk adjusted returns and

in all likelihood increase the probability we stick to our investment plans and

meet our financial goals.

Risk adjusted return is particularly important for

investors in portfolio returns make up a large portion of their total income

such as those at or near retirement.

These investors are subject to what we call sequence risk.

Because they must withdraw from their portfolios over time, they care very much

about their sequence of the returns they receive on their investments.

Significant losses in the first few years of retirement, can make it difficult for

investors to meet their financial goals.

For example, those who retired in 2007, and

began withdrawing from their portfolios,

could have found their invested assets cut in half after just one year.

But their cashflow needs unchanged.

Depending on how much they withdraw each year.

This could've been a significant obstacle,

to sustain their standard of living throughout retirement.

Designing a portfolio with risk-adjusted return in mind may sacrifice some upside

in order to avoid the kind of volatility or

drawdowns that can knock investors off the course.

I hope you've found this video helpful.

Investors who internalize the concept of risk-adjusted return

are well on their way to understanding how to build an asset allocation,

benefit from diversification within and across asset classes, and

give themselves a smoother investing ride than they would otherwise have had.

Thank you again for watching.

[MUSIC]

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