Evolution Of Risk Management
Over their relatively short lives, millennials have experienced two major bear markets: the tech bubble of the late 1990s and the financial crisis of 2008. And the latter happened just as many millennials were starting their careers, which meant they bought into retirement accounts at the market peak. This has made them cautious about selecting asset classes and prompted them to avoid buy-and-hold strategies, which worked well for baby boomers. So millennials may be more inclined to embrace active allocation approaches that focus on risk management.
Traditional stock-to-bond management is a thing of the past. The first step in risk management evolution is risk measurement—within asset classes and for individual securities. After all, the risk inherent in large-cap stocks differs from that of small-cap stocks, as the risk in corporate bonds differs from U.S. Treasuries. Once risk is measured, it can be targeted in a way that keeps the investor feeling comfortable with the portfolio. This will ensure expectations are met and provide a smoother and more diversified ride over time.
The second step is factor modeling. It is important to understand whether a portfolio has any unintended risk exposures, and factor risk management can help. It often involves complex and expensive analytical tools that run in-depth quantitative analyses, but these tools, and the knowledge of how to use them, are quite necessary. While stock picking may seem simple, investors need to understand how each security interacts with every other security in a portfolio. This is not something the human brain can do on the fly. A portfolio needs to be consistently analyzed to ensure risk exposures do not change over time and new trades do not disrupt favored factors.
A focus on risk management will help millennials feel confident about their investments, letting them know their portfolios are managed to their comfort levels, regardless of changes in financial markets. It also allows for active asset allocation to potentially boost returns, while staying within risk targets.
Millennials are quickly becoming the target market for financial advice, but advisors need a different approach to match their investment management needs. A precise focus on advancements and evolution within financial products, values-based investing and risk management are the keys to impressing millennial investors.
Kostya Etus, CFA, is a portfolio manager for CLS Investments.