This investment insight for the institutional investor discusses a more refined method of managing and mitigating loss.

  • The concept of risk is typically not well defined and can even be subjective, making “risk arithmetic” challenging to understand if not outright misleading.
  • Standard deviation, the broadly used default risk metric, has significant limitations.
  • The concept of “drawdown” is a more intuitive and therefore useful approach to understanding and tracking investment risk.

Risk is a central theme in the investment world—a core tenet that underscores every step of our investment process—and a counterweight to an investor’s desire for return. The irony is that, given the enormous role and usage of the term, the concept of investment risk is typically not well defined and can even be subjective, making “risk arithmetic” challenging to understand if not outright misleading. Return, on the other hand, is easily defined by the growth or decline in the market value of a portfolio. As detailed below, standard deviation, the broadly used default risk metric, has significant limitations. This leads us to embrace the concept of “drawdown” as a more intuitive and therefore useful approach to understanding and tracking investment risk.

Please see important disclosures at the end of the article.

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