Scripbox’s Approach to Risk and it’s Management

For most investors, “risk” usually means loss of capital. The riskier the investment, the more attractive it should be in terms of returns. But there is no guarantee of high returns if you have taken a higher risk. However, there is no escaping higher risk if your goal is higher returns. To understand how we here at Scripbox manage risk, let’s look at the various forms it takes and how we address them.

What is Risk

Relationship between risk and reward

In order to attract capital, risker investments have to offer the prospect of higher returns (higher average returns) – but there is no guarantee that these prospects have to materialize. Higher risk does not necessarily mean higher return, but in order to make a higher return, one must necessarily take a higher risk. 

Forms of Risk

In the context of investing, risk can take on multiple forms. 

Loss of Capital (absolute loss): 

A permanent loss of value in any investment is a real possibility. This risk can be mitigated by diversification of the investment corpus across multiple investments. Spreading investments across can ensure that a permanent loss of one investment will not lead to a total loss of capital.

A mutual fund does this for you by assigning a fund manager to make an informed decision on investment selection.

This analysis looks at the performance of listed companies and equity mutual funds over the past ten years. 

Listed Companies
Market Capitalization Lost	Number of Companies
>80%	242
>70%	116
>60%	90
>50%	104
>40%	82
>30%	71
>20%	65
>10%	73
No. of companies whose market capitalization was less than 2012 levels	843
Total no. of companies	2738
% companies whose market capitalization was less than 2012 levels	31%
Equity Mutual Funds
Schemes with a CAGR > 15%	88
Schemes with a CAGR > 10%	155
Schemes with a CAGR < 10%	0
Schemes with a Negative CAGR	0
Total Number of Merged/Closed Schemes	57
Total Number of Schemes	212
% of Schemes with Negative 10-year CAGR	0%

Loss of Value (returns below inflation)

When investing, the primary benchmark is the rate of inflation since investment is consumption deferred to a later date. A long investing horizon tends to reduce the possibility of lower-than-inflation returns.

The data in the below table shows that when the investment holding period is longer, the probability of getting an inflation-beating return is higher. 

Insufficient Returns vs Planning Assumptions

One risk in investing is the insufficiency of returns vs what was factored in when planning. At Scripbox, the approach is Data Driven. We minimize this risk by looking at past performance and taking a range of returns approach rather than an average returns approach. 

What we do at Scripbox is look at historical data over extended periods of time to get an insight into what were the past scenarios like. It is not to say that the past will play out in the future; it only gives us an indication of how multiple scenarios had played out and thereby gives us a better understanding of the range of possibilities. 

Duration	Average Return	Standard Deviation
1989 – 2022	15.4%	7.5%

Calculation: 1-year rolling return

The graphical representation of the above table is mentioned below:

Opportunity Loss (underperformance against alternatives)

The future is unknowable. Being able to predict which fund will be top of its class is not possible. We look at funds as a means to evaluate investment managers, and we evaluate them on the basis of parameters that we believe are important. 

The evaluation parameters and their respective weights (algorithm) have been arrived at based on our experience and empirical tests of how such evaluations have panned out in the past. We believe that if applied diligently, the result of these would have a high probability of performing better than their category averages.

Is volatility a measure of risk, and if so, how?

Not every change is risky. Volatility, in very simple terms, means how a value changes and how quickly. What gets talked about in the case of investing are two kinds, Return Volatility and Price Volatility. At Scripbox, we concern ourselves more with returns volatility rather than price volatility.

Return Volatility

The predictability of returns is an important factor in investing. We think of it as an important risk since this can lead to sub-optimal experiences. Investors are willing to pay a premium (which translates to accepting a lower return) for predictability and certainty of outcomes. At Scripbox, when we look at any asset, we look at long-term investing experience and consider the range of outcomes.

Price Volatility: 

The inter-period price changes (day to day/month to month) can be of some concern to investors. This is especially true of risk-averse investors who tend to keep a close watch on daily portfolio moves, etc. Increased price volatility impacts investor behaviour by resulting in untimely withdrawals, etc. 

This can be managed by choice of investment vehicle, periodic interventions and reinforcement (more focused on behaviour) etc. An asset allocation approach to investing tends to result in better outcomes, that is, adequate exposure to more stable asset classes as part of the portfolio.