How do you make sense of the investment risk data in a fund’s factsheet?
I’ll be honest, big-wave riding just looks like a bad idea to me. Mostly because it seems like there is a fairly good chance I could die doing it.
For me the risk is clear. It is significant. And it could impact very negatively on my future plans.
It makes not getting involved in big wave riding an easy decision for me.
From the picture I can tell that at least one guy in this world does not agree.
But not all risks are as easy to identify, measure or avoid as this.
Everything involves some risk. Driving a car, falling in love and statistically apparently using a step ladder.
My wife has some pretty strong thoughts on how I approach all three of those risky things. Her thoughts probably evolve over time and depending on the circumstance.
Similarly, our attitude to risk in our financial lives also evolves depending on our circumstance, life stage and possibly what we have experienced in the more recent past too.
From an investment perspective we can get a pretty good idea ^ of the probability and magnitude of risk from a factsheet (or the more commonly used, yet less intuitive name – Minimum Disclosure Document or MDD).
^Caveat: This is only true if the time period we are assessing is long-enough to be meaningful. 25 years is pretty good. 5 years is pretty meaningless.
Where to find the stats in the first place
You can find these documents, updated monthly, for any listed fund or ETF, on your favourite product providers websites.
From the Allan Gray Balanced Fund* factsheet as of 31 October 2024, you can see how this return & risk data gets presented:
*chosen because it has one of the longer track records rather than it is one of my favourites.
In the words of one of my clients this week when I sent him a factsheet – ” I don’t speak Chinese.”
I can see where he is coming from – it is not very clear what it all means. I have been analyzing this kind of information for over 27 years now. So sometimes I can forget it is not as straight forward when you see this stuff for the first time.
Can I explain it in better terms for you so you can understand what the basic story is?
I don’t know but am definitely keen to try. You can give me feedback on whether I was successful or not if you like.
The Allan Gray Balanced Fund has an inception date of 1 October 1999. That means it was started 25 years ago and we have some useful data as a result.
Rather impressively, the average annual return over this whole period is 14.8%. Every single one of us would and should be thrilled with a return profile like that.
But we know returns like that do not happen in a nice straight line.
So what did holders actually experience and endure through this period?
The risk statistics provides us with some ideas.
The following graphic puts this risk & return data into the context of how much Rand you would you have made or lost per R1000 you had invested at any point in time.
How to interpret this information?
Average Annual Return (green):
Over the entire 25 year period your average return per year would have been R148 per R1000 invested at the start. But if you have ever monitored the performance of your retirement funds you will know that this average return is hardly ever achieved in any one single year out of the 25. Returns are usually higher or lower than the average in any single period.
Range (light blue & pink):
So we know not to expect the average. What can we expect then? Well the VOLATILITY data in the factsheet above tells us that 68% (or most) of the time, our R1000 earned about R90 more or R90 less than this average (R148). In other words we can expect the returns per R1000 invested to range between about R240 on the upside and about R60 on the downside.
Worst Year ever (orange):
So the range tells us that most of the time over the past 25 years we could be quite comfortable that we should not experience losses. But we cannot simply ignore that pesky 32% of the time where losses can and do occur. So how bad have these losses been? Over any 12 month period the most you would have lost is R141 per R1000 invested.
Worst peak-trough loss (red):
In the factsheet this is called the MAXIMUM DRAWDOWN. It tells you what the worst loss is that you have experienced had you put your money in at a high and sold it at a low (regardless of what period of time) during the 25 years. This turns out to be R250 per R1000 invested. That can feel pretty scary when it happens of course.
Best year ever (dark blue):
The best 12 month period you would have ever experienced saw you earn R460 per R1000 held in the fund. High fives, champagne corks popping, rock star investor badges handed out at rewards ceremonies and the like. Well hopefully not of course. Exceptional years are great but they usually make things more expensive and expensive things usually don’t enjoy the best time in the years immediately thereafter.
Why should you care?
Balanced funds (or Multi-Asset Funds), like the one above are designed to comply with the rules governing what retirement funds can invest in (Reg 28). They hold a mixture of the typical things you can invest in like shares, bonds, cash, property etc.
Most of us own something similar.
They are broadly termed MEDIUM risk.
You can make some good returns overall. (ahead of inflation so protecting your purchasing power)
Most of the time you will enjoy positive gains in your portfolio value.
But every now and then you should expect to be nursing some losses. Sometimes these losses can feel very uncomfortable.
But if you can get to grips with this information and manage your expectations around your investment returns, you are far less likely to do anything silly when the inevitable storms arrive.
If you found this interesting you should also go and contrast the Money Market and Equity Fund factsheets from Allan Gray which will give you a idea of both a lower and a higher risk return profile than the balanced fund used above.