CLS's Risk Budgeting Methodology

Since 2000, CLS’s Risk Budgeting Methodology has been integral to the execution of our portfolio management because of three core beliefs:

  • All investors have a capacity to bear some investment risk. The best way to manage risk is to measure it, rather than relying on a traditional stock-to-bond ratio.
  • Over the long term, investors are rewarded for bearing risk; having too little may hurt portfolio returns.
  • Investment methodologies should be designed to pair a disciplined risk management system with an active and flexible approach.

The term “risk” as it relates to investing may have negative or scary connotations in an investor’s mind. And it is true that riskier assets have a greater chance of decreasing in value at some point. Yet, taking on risk in the investment world can also bring reward, as riskier investments tend to have greater potential to significantly increase in value. The key is to find a balance between lower risk and higher risk investments that is appropriate for the investor’s specific investment objectives.

CLS’s Risk Budgeting Methodology is flexible enough to be applied to a broad variety of investor risk comfort levels, from aggressive to conservative. We have also found that most investors have one of four main investment objectives (which may change over their investing lifetime). Within these categories, we either wholly apply our Risk Budgeting Methodology, or combine it with other approaches.

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Establishing the Risk Budget

Finding the optimal asset mix is not always easy, but that’s where CLS comes in – we have been building individualized, balanced, global portfolios since 1989. Our Risk Budgeting process starts by defining the investor’s personalized Risk Budget, based on his or her unique investing time horizon and specific investment goals. This budget is the level of risk, relative to a diversified, global equity portfolio, at which we manage the portfolio.

Measuring Risk

CLS uses a proprietary risk calculation to measure the risk of each asset within the portfolio to ensure the combined risk level of the portfolio is suitable for the investor’s individual needs. The measure takes into account the asset’s relative volatility (“relative standard deviation”), its relative movement to the market (“beta”), and its behavior during months with negative stock market performance (“relative maximum drawdown”). We are careful to not underexpose the portfolio to risk, as this may not give it adequate opportunity to grow. Yet we do not overexpose it, as this could leave the investor unable to meet his or her financial obligations.