New Techniques  |  APR 1998

What Is Risk? by Gary Anderson

What Is Risk? by Gary Anderson There are many ways to view risk. Some measurements treat risk and reward alike; if a stock is outperforming the market to the upside, there is an implicit expectation that the stock may also outperform the market to the downside. This article introduces the concept of comparing how a stock performs during up movements relative to a benchmark and then, separately, measuring performance relative to downward movements by the benchmark. Risk is routinely measured as standard deviation, or volatility. Certainly, volatility is risky. But as a definition, volatility does not cover what most of us mean by risk. Could we come up with a more intuitive measure of risk than we have available? In order to be relevant, any workable approach must be guided by the practical concerns of investors. In order to communicate, our language would have to remain true to ordinary definitions. A method with which to measure risk that everyone will understand must be based on what is already a given. With this in mind, we asked a basic question of clients and colleagues: Why do investors hire managers? The answers that came back to us were consistent and not very surprising: First, investors hire managers to create gains, and second, investors hire managers to protect capital against loss.

by Gary Anderson