Risk Can Be Measured

By David McEwen

Tuesday 19th June 2001

Contrary to popular opinion, New Zealanders are pretty good savers. They are also active investors. Unfortunately, there seems to be a significant flaw in the kiwi character - an inability to accurately judge risk.

New Zealanders were not the only ones to push up the price of shares to absurd levels in the late 1980s, but we did it to a greater degree than anyone else. We also have had more than our fair share of booms and busts in areas like goats, kiwifruit, ostriches, phone cards and so on.

Kiwis tend to put a lot of money into property, but returns aren't always worthwhile relative to the risks taken. Anyone who has bought a rental property and been enable to find tenants can testify to that.

Many investors have been taken by surprise that a bond issue to raise funds for a luxury apartment block in Auckland has come unstuck - even though it was paying a 14% yield. Sorry, but you can't get high returns like that without there being an equally high level of risk.

As investment advisers like to say, "The higher above 10% a yield goes, the closer it gets to zero".

Investors need to understand the risks they are taking with different asset classes, and what returns they should get to justify each category of risk.

Unfortunately, there has been little publicly available research on this subject of specific relevance to New Zealand - until now.

Economics, finance and investment consultant Brent Wheeler has produced a table of risks and returns for New Zealand investments on his website (www.brentsjam.com/riskprofile.htm).

He rates investments according to measurements like liquidity (how easy it is to sell the asset), volatility (how far and how often the price of an asset rises or falls) and Beta (how the price of an asset moves relative to the market). From this information, plus his own experience, Brent has worked out what premium above the Reserve Bank overnight cash rate investors in different types of assets need to earn to justify the extra risk they are taking.

Fancy buying a nice little suburban home as a rental property? Don't do it unless you can get a return of at least 10.35%, his table says. It just isn't worth the risk otherwise.

Want to buy some shares? Look for a return from relatively safe utilities of at least 7.75% (from dividends and capital appreciation) to make it worth your while. If you are going to risk your money on technology shares, better aim for a return of more than 30% a year.

Even different types of government stock get the treatment with ten-year stock requiring a 6.09% yield compared with the one-year needing only 5.98%.

I am not aware of any other comparative table such as this in New Zealand and think it is a useful tool for investors. Brent stresses that the figures are merely estimates and is looking for feedback from investors to further hone his calculations.

This table does nothing to reduce risk itself but it may help investors avoid unnecessary risks.

There is no way to avoid all risk in life. However, it's much easier to deal with risks that you know about and can measure rather than those that sneak up and bite you.

David McEwen is an investment adviser and author of weekly share market newsletter McEwen's Investment Report. He is commissioned by the New Zealand Stock Exchange to write an independent personal investment column. He can be reached by email at davidm@mcewen.co.nz.

Comments from our readers

No comments yet