The higher the risk taken by an investor the wider the potential returns both negative and positive. A high risk investor would expect to be compensated by higher positive returns in the long term when compared to a low risk investor. The crucial difference will be the journey to the end result. The high risk investor is likely to have experienced larger falls and larger gains along their investment journey. The important point is that the higher risk investor is comfortable with and expects such a journey to achieve the desired end result i.e. a higher positive return.

Volatility percentages, used in association with an expected average return, expressed as a range of figures both negative and positive can be very helpful to investors in deciphering what may be meant by a generic “low”, “medium” or “high” definition of risk.

This is where effective client risk profiling has a very important role to play. Behavioural finance has an instructive input here as it is generally accepted that most investors feel the impact of a loss at least twice as much as a gain. It makes sense to factor this into an investment decision process for effective management of investor expectations.

Recent fund design innovation has introduced the concept of risk targeted funds which specifically target a range of volatility and aim to generate the optimum return for that specific level of risk. The benefit to investors is the investor will invest in the appropriate risk targeted fund for their individual profile and because the fund is managed to a volatility target, the risk profile of the fund won’t change over time. This confers many obvious advantages to the investor and their adviser and is a substantial reason for the growing attractiveness, interest and growth in funds under management in these funds.

The importance of volatility to the investment industry has been highlighted by recent regulatory changes, fund innovation together with a refreshing focus by fund managers on controlling risk from the investor’s perspective. Understanding and getting comfortable with the concept of volatility is fast becoming a necessary investment tool for investors and can only enhance the credibility and transparency of the funds and investment advice.