Content Provided by Case Eichenberger, CIMA, Client Portfolio Manager
Which portfolio would you expect to be riskier? A or B? Or, put another way, which portfolio would you expect to be more volatile?
Tough call, isn’t it? They both look very similar in terms of stock-to-bond ratios. Let’s call it a wash — they both hold the same risk.
How about now?
In this example, the fixed income (bond) portions of the portfolios have been isolated. They are still pretty similar, but portfolio A has a little more invested in non-Treasury or securitized-Treasury debt, so A may be riskier but not by much. Perhaps not even enough to generate a noticeable difference.
How about now?
Digging a little deeper on fixed income reveals the credit quality of both portfolios. Lower grades (BB and below) are considered junk bonds — meaning they have higher yields but higher chances of default. A has more invested in junk bonds, which are not as safe as Treasuries and AAA corporate bonds, so we can conclude that A is riskier. I think we are getting closer to our answer.
This one is a little more obvious. A is the clear choice as it has a higher standard deviation and higher beta to global stocks.
The interesting point is these are all the same two portfolios, just viewed differently. The individual positions are listed below.
Portfolio A is tilted toward high income generation, and portfolio B is a true total-return, core portfolio. Portfolio A is riskier, but that is not obvious until the data (standard deviation and beta) is examined.
At CLS, we would assign portfolio A a 70 Risk Budget score and portfolio B a 60. That’s a substantial difference. When we review and allocate portfolios, we take a close look at all relevant data points to ensure the risk assumed matches the client’s comfort level. We also avoid using stock-to-bond ratios as we believe these do not provide accurate portraits of portfolio risk. While these portfolios are composed of very similar 55/45 stock-to-bond splits, they are revealed to be quite different under the hood.