Business cycle is unpredictable, the return expectations, based on the previous 10 years, would probably be unrealistic in the future. Absolute return strategies, which are never supposed to post a negative return, posted –20 percent returns during 2008 financial crises. Investments that are supposed to be liquid actually—in extreme conditions like 2008— are not as liquid as expected and that their diversification strategies work only under normal market conditions. Such events call for a need of change in wealth management thinking and wealth managers need to change their definition of risk. Risk should not be defined mathematically as a standard deviation of return but as the probability of not achieving goals, which is the way that most people intuitively define risk. After all, although the volatility of returns is a matter of concern, it is not the same thing as failing to meet goals altogether. Thus, focusing on investors’ goals is a better way of wealth management.
The industry was created by institutional investors who tended to have one goal: to meet their liability stream. All institutions—whether pension funds, foundations, endowments, or insurance companies—use their assets to defease a particular liability. Similarly for individuals should not think in terms of risk and return but in terms of dreams and nightmares.
Hitesh Gulati, CFA 