An analytic review of risk-driven portfolios

Abstract

Whenever market stability is challenged, due to unforeseen events such as the Global Financial Crisis, volatility rises and financial markets fluctuate, presenting a significant set of challenges to investors. In wake of the crisis, despite the strengthened monetary policies enforced by Central Banks worldwide, unanticipated spikes in volatility over recent years quickly provided a stark reminder to investors of the potential impact of market volatility on portfolio performance. Given that volatility is at the centre of most investment decisions, investors began seeking further protection against rising volatility through alternative investment strategies, in an attempt to move away from the traditional portfolios focusing on a static asset allocation. This research, which was carried out based on a local perspective, focused on the benefits associated with one particular alternative portfolio, specifically known as a “Risk- Driven Portfolio,” which incorporates a dynamic asset allocation approach, effectively rebalancing asset allocations in response to market conditions. Such portfolios were recently introduced to the Maltese investment market, in order to address the higher risk being taken on by local investors chasing higher yields through riskier investments. The general aim of this research was to identify the distinguishing benefits of such portfolios, in comparison to the more traditional portfolios that remain static in their asset allocations, irrespective of the underlying market conditions. By using a qualitative approach, the research identified numerous contrasting opinions and responses, therefore concluding that whilst risk- driven portfolios are extremely beneficial to manage risk, they require more rapid investment decisions to be made, to keep within the desired volatility constraints. However, the overall consensus was a positive one, and these portfolios proved to be of particular interest to the majority of research participants, demonstrating the need for additional portfolio protection during market stress, especially in anticipation of future higher interest rates in the coming years. The research encapsulated both the individual investor’s interest, as well as financial advisors’ opinions on such portfolios, whilst also gaining further insight to the topic from a professional perspective.