Join our community of smart investors
OPINION

The risk factor

The risk factor
April 12, 2017
The risk factor

Is it ever possible to see, or hear, the spanner whistling through the air before it smashes into the works? Many risks are easy to see. Airlines are vulnerable to rising fuel costs and retailers to economic downturns. For pharmas it’s patent expiries, drug failures and lawsuits. Some sectors, take consumer discretionary, even have risk written into their name. This is why we diversify so that we don’t hold too many companies facing the exact same risk.

Some risks are well camouflaged and difficult to spot from the outside, such as fraudulent activity by employees. Tesco executives overstated its profits by hundreds of millions, and BT had to confess to an accounting scandal in its Italian arm. TalkTalk's shares plunged after its data was hacked. Risks relating to freak accidents or acts of nature, such as Icelandic volcanoes, are even trickier to identify in advance.

How can you see these visible and invisible risks? As Chris Dillow wrote recently: “We need to remember about any issue that the true evidence base is often wider than we think; it comprises the unseen as well as the seen.” The first step is to pay proper attention. Are you clear what the company does and do you understand the market it operates in and why, say, it has high debt? Read the annual report. Most companies will discuss the main risks they face. But don’t expect them to highlight weaknesses they don’t want the outside world to know about, such as competitors they’re worried about or that their security spending simply isn’t enough. Get better at spotting risk by making a list of sector-relevant and general threats and thinking about what’s not in the picture.

Review your portfolio after each Imagination-type incident.

If you lost out before when a company lost a key customer, you might have been twice shy when it came to Imagination. If you hold shares in outsourcers you will know that a contract win from government can mean a rocky ride ahead with costly mistakes, low margins and a hostile public reaction.

Safe shares don’t always trump risky ones. Investing is about returns as much as it is about risks. By scrutinising your shares for risk, you should see clearly the mix of risks in your portfolio. If a company you plan to buy looks like it falls into several risk categories, and can therefore be labelled high risk, you might want to only buy a small holding to begin with, or to take profits from time to time if it does well – don’t let down your guard. Assessing risk doesn’t mean trying to avoid it at all costs, instead it should encourage us to consider if we are comfortable with the way it’s tilting our portfolio.

Rosie Carr is deputy editor of Investors Chronicle