Know the risk of your investments

I find Grand West Casino one of the most fascinating places to visit. 

Not because I like to gamble (because I don’t), but because people fascinate me. 

When they enter the casino, they’re all smiles and everyone’s full of enthusiasm. 

But when they leave, it’s usually a different story. 

It’s exactly this mood change that I always found fascinating, until last Saturday. 

I decided to play the Lotto and I felt great after purchasing my ticket. 

By the time of the draw later that evening, I already felt like a multimillionaire. 

Like I had already won the millions and I knew exactly how I was going to spend them. 

Of course, this was followed by sobering disappointment as I didn’t even manage to match two of my selected numbers to the winning numbers. 

Not only did this teach me a lesson about the risks of gambling, but also about investing in the JSE.  

No one can predict the future. You can, however, determine the amount of risk you will be taking before making an investment. 

If I had done this last Saturday, for example, I would have realised that I only had a one-in-20 million chance of winning the Lotto and that I would have gained more by spending that R2.50 on sweets. 

One of the most effective ways to determine risk when it comes to the JSE, is by referring to the volatility ratio. 

This ratio expresses historical up- and downward price movements as a percentage measured over a certain period of time. 

If a share trades on a volatility ratio of 20%, for example, that means that it could possibly provide a shareholder with either a 20% gain or 20% loss over the next 12 months. 

It goes without saying that if you insist on managing your own pension fund, you have to know exactly what your risk classification is before you start to buy shares. 

In simple terms, if your pension currently barely fulfils your financial requirements on a monthly basis, you cannot afford to take on too much volatility in your invested capital. 

The reason is quite obvious – if markets turn against you, you’ll be caught between a rock and a hard place and you’ll run the risk of outliving your capital. 

It’s understandable that an investment with a volatility ratio of 16% will seem irresistible for its ability to possibly outperform inflation by 10%, but investors shouldn’t forget that they have to be willing and able to accommodate for a possible 16% loss as well.

This is exactly what you should be willing to risk if you want to invest your capital in the JSE right now (current 260-day volatility ratio of 16.09%). Although this remains high for the conservative investor, it’s still lower than the ten-year average 260-day volatility ratio of 17.75%.

The top ten largest shares on the JSE – Anheuser-Busch InBev, BHP Billiton, Naspers*, BATS, Glencore, Anglo, Richemont, FirstRand, Standard Bank and Sasol – are currently 17% less volatile than the remaining 154 shares listed on the FTSE/JSE All Share Index. 

This can largely be attributed to the strong growth experienced in developed countries and the fact that these shares have all started to leave deeper footprints internationally. 

In fact, six of these shares already have their primary listings offshore. 

The largest portion of Naspers, called Tencent, can certainly also be added to this list. 

Although volatility is a measure used to tell you more about the past and is not necessarily an indication of future performance, there are a few shares closer to the bottom of the volatility list that caught my eye: AECI, Investec and Remgro. 

Not only do these companies’ forecasts look promising for the next few years, but they also carry 18% less volatility compared to the average volatility of the top ten largest shares listed on the exchange. 

I would like to conclude by pointing out to investors that shares may have stood out as the investment with the best returns over the years, but it also came at the cost of higher risk (volatility). 

When you consider a particular investment, you have to be absolutely sure of the possible risks linked to your expected returns.

*finweek is a publication of Media24, a subsidiary of Naspers.

Schalk Louw is a portfolio manager at PSG Wealth.