Risk and Reward – The Balance in Stock and Bond Investing

Effective risk management assists investors in navigating challenges
Diversifying investments is key to controlling risk, helping to avoid reliance on a single asset class or region, and reducing concentration risk and volatility
Multi-asset solutions assist in balance risk and return by diversifying investments across various regions and themes

In today's evolving market environment, investors are confronted with increasing challenges. Risk management has become a key factor in successful investing. To effectively control risk, it is important to recognise that risk levels can vary within each asset class.

Bonds are largely classified into two categories based on their credit ratings. Investment-grade bonds have credit ratings of BBB-/Baa3 or higher, indicating that the issuers possess strong credit fundamentals, a solid ability to meet debt obligations, and relatively low investment risk. Bonds with ratings below the aforementioned threshold are categorised as high-yield bonds, reflecting weaker financial positions and a higher risk of default. Bonds can be issued by both governments and companies. Sovereign bonds generally offer lower returns but come with lower risk compared to corporate bonds. Bonds issued by financially stable developed countries like the UK and the US, are considered investment grade. In contrast, sovereign bonds from emerging markets, with less stable fiscal or political conditions, such as Argentina and Turkey, are high-yield bonds.

Compared to bonds, equities generally carry higher risks, but risk levels vary within equities. Defensive dividend stocks, such as those in the utilities and telecommunications sectors, tend to have lower risk. These sectors are less sensitive to economic cycles, as demand for basic necessities, such as clothing, groceries, utilities, and telecommunications, remains steady regardless of economic conditions. In contrast, growth or cyclical stocks, such as those in technology and consumer discretionary sectors, are considered higher risk. These sectors, characterised by relatively higher growth, often see companies reinvesting their earnings for business development rather than paying them out as dividends or maintaining a low payout ratio. However, if growth fails to meet expectations, the share prices of these companies may undergo sharp corrections, resulting in greater volatility and risk. Additionally, commodities are also considered high risk due to their price volatility and sensitivity to geopolitical events. Nonetheless, assets such as energy and gold can serve as effective hedges against rising inflation or economic downturns.

ETFs as risk diversifiers

As discussed above, different types of equities and bonds carry varying risk levels. Before deciding how to allocate assets, investors should evaluate the situation from a risk management perspective to determine whether a proactive, conservative, or neutral approach is most suitable for the prevailing market conditions. Diversifying investments is a crucial strategy for controlling risks; relying on a single asset class or region can increase concentration risk and investment volatility. Investors who are confused by complex global market trends can consider multi-asset solutions available in the market. One type typically comes with a predefined asset allocation ratio, while the other conducts systematic risk assessments to determine the asset class ratio, before allocating assets across regions and themes through ETFs. ETFs can invest in equities, bonds, commodities or a diverse mix of assets, enabling proper risk diversification. A multi-asset investment approach that prioritises risk management adjusts asset weightings according to market shifts, effectively balancing risk and return in an optimised manner.