# FAQs

### Frequently Asked Questions

Most people understand the concept of a financial budget - whether as individuals; households; clubs; or even Governments (to some limited extent).

As you probably know, your investment portfolio can defined by the way you allocate funds to selected investments - this is well known as your **asset allocation**.

But, did you appreciate that for every asset allocation - there is a shadow **risk budget** that is implied by the riskiness of your portfolio and where you invested across securities? For every portfolio, there is a risk budget revealing the **concentration of risk** within your portfolio. The risk budget provided major insights when you compare the **% invested** (i.e. a securities asset allocation) with **%contribution to portfolio risk** (i.e. a risk budget).

Both insights are related to **Diversification** and in some settings to **Portfolio Optimisation** (i.e. portfolio risk decreases as we invest in more securities or optimise).

It is important to realise that diversification does **NOT** have a unique **stopping rule** - although many believe 15 to 30 securities may be an appropriate interval - this is only true in the context of **MEAN-VARIANCE** portfolio theory made popular by Harry Markowitz (1952).

Your risk budget cleverly reveals the risk anatomy of your portfolio (at the point where you stopped diversifying your portfolio).

A comparison of the **% invested** with the **% contribution to risk** for each security or sector in your portfolio reveals imbalances between what you invested in AND how the portfolio risk is concentrated - i.e. these are your 'big bets'. Was that intended?

During the period 1952 to the early 1970s, the dominant measure of portfolio risk was **standard deviation** - consistent with the belief that measured returns on portfolios and securities had a frequency distribution approximating the **normal** (bell-shaped) distribution..

The 1970-1980 period witnessed portfolio theory and its popular valuation models under stress. In short, very few portfolios had periodic returns that could be categorised as 'bell-shape'. Non-normality was found to be widespread in financial series. Anomalies began to appear in many financial studies. New factor models were promoted.

Now, after serious problems in the capital markets crash, the most general and important measures of portfolio risk are estimated as tail risks - that are NOT related to the 'bell-shape' assumption.

For completeness, IRISKONLINE provides risk estimation in terms of Standard Deviation (SDEV); Value at Risk (VaR); and Expected Shortfall (ES) - which **ALL** assume the **bell-shaped curve** (Normal) describes returns for your portfolio. And sometimes it is accurate!

But most importantly, IRISKONLINE provides you with more modern risk measures that adjust for non-normality.

These are labelled: **Modified Value at Risk (MVaR)** and **Modified Expected Shortfall (MES)**. And IRISKONLINE, provides a focus on **extreme portfolio losses estimated at the 95% confidence limit**.

Some analysts use **behavioural questionnaires** to identify 'risk tolerance' - but these are typically invalid due to the lack of a clear link between the question being asked **and** your attitude to investment losses.

**IRISKAWARE** is an application with a unique approach to help you find a suitable **Investment Strategy** based ONLY on a revealed estimate of the extreme 5% tail loss in the empirical distribution.

**IRISKAWARE** presents a new approach that simply requires you to examine and consider extreme '**loss estimates**' associated with each of 90 anonymous investment investment strategies.

Hiding the actual ASSET ALLOCATION and ASSET CLASSES ensures that your decision is based ONLY on the '**risk of expected loss**'.

Those key portfolio risks are displayed as you HOVER over each strategy hidden under a grid defining the risk space - with more information and selection available on CLICK.

And the ONLY question you need to address is simply:

**if there was a 5% chance that a selected strategy could lose x% in any month - would you find it acceptable?**

If so, perhaps you may '**LIKE**' the strategy with such an expected outcome.

Once you have identified 3 LIKES, the CENTROID is estimated and all 4 strategies define the '**strategic risk space**' in which you are comfortable.

These strategies are most likely to be consistent with your attitude to risk.

You can then UPLOAD those strategies into IRISKONLINE and start to consider the IMPLEMENTATION phase where portfolio risk must be as close as possible to the strategic risk.

The Portfolio Report simply provides you with a PDF summary of any selected portfolio in IRISKONLINE.

The report is focussed on the selected portfolio; its investments; its risk structure - and the risk budget it reveals.

This may be an efficient approach for you to provide documented evidence to Auditors; Trustees; Advisors etc - that your portfolio has been **IMPLEMENTED** as a valid approximation to the investment **STRATEGY** you wanted. The insights in the report are more than just a 'statement of holdings'. Instead, it uses a **RISK BUDGET** to show you where your portfolio risk is concentrated - thus indicating where you believe the **Expected Return** will emerge. In that sense, the portfolio report is documented proof that you understand and manage risk appropriately.

This is particularly useful for trustees of self-managed superannuation funds ('**SMSF**') that must comply with the law - consideration of Risk.

**Implementation Risk** is an inevitable consequence of mapping a normative '**STRATEGY**' into an effective '**IMPLEMENTION**' - and any risk differences between them needs to be kept as small as possible (often called 'tracking error' in the jargon of funds management).

IRISKONLINE provides a very smooth transition from **STRATEGY** (IRISKAWARE) to **PORTFOLIO** (IRISKONLINE).

A **Portfolio Risk Control Chart (RCC)** is used in **IRISKONLINE** to compute and display key monthly features of a dedicated portfolio. The data required for that purpose is held in a secure database from **Amazon Web Services (AWS)**.

In a single **CHART**, you can view and manage any **IRISKONLINE** portfolio with a **RCC** attached:

1. Your portfolio's estimated monthly rate of return is computed using a **Time Weighted Rate of return (TWR)** method that adjusts for all **CASHFLOWS** impacting your account during the **MONTH;**

2. A personal **PORTFOLIO PERFORMANCE** **INDEX** is constructed from the **TWR series **providing you with a visual indicator for how well your portfolio is performing over time;

3. **PORTFOLIO VALUE** as at the end of the month is displayed as a vertical **BAR CHART**;

4. The estimated extreme RISK estimates for losses in the 'left tail' of your portfolio's **return distribution** are shown for **Modified Value at Risk (MVR)** and **Modified Expected Shortfall (MES). **If the **ANY BAR** in the vertical **BAR CHART** cuts across the **MVR** and/or **MES** - this may suggest that your portfolio is significantly outside its risk limits.

5. What are the Intervention Strategies to consider if 4. arises? **FIRST**: check for data errors in **IRISKONLINE** - units held; security prices; **SECOND**: check your broker/pricing site (e.g. COMMSEC) - possible announcements; capitalisation changes; suspensions; capitalisation changes (share splits)

6. Keep in mind that the risk limits are 'EXTREME' - only a 5% chance of a breach. In the absence of 'error' there is a 95% chance of recovery. Do not panic!

7. The process, although quite simple, requires you to enter the relevant month's transaction data from the bank statement that displays buy/sell cash flows to settle transations for e.g. beginning value; purchase/sale of securities; interest; dividends; and other investment related withdrawals and deposits.

Without doubt, the RISK CONTROL CHART is one of the most interesting features of your portfolio reporting.

The RCC image can be downloaded as PNG file and distributed to your Advisor; friends; family and any interested party.

A IRISKCONTROL chart is available for a DEDICATED NOMINATED portfolio on an ANNUAL subscription service provided by IRISKONLINE.

As you may appreciate, the IRISKENGINE calculations are extremely complex- and that creates conditions for anomalies. So, some care is required for certain portfolio designs.

These show up clearly in the portfolio's 'higher moments' - skew and kurtsis.

There are a number of unavoidable situations where extreme results are likely to emerge:

1. When a security with a basic minimum of monthly observations is held in a portfolio; and/or

2. When TWO securities are virtually the same e.g. TWO cash funds; TWO ETFS that are essentially identical; and/or

3.