Stocks Systematic Risk
Stocks Systematic Risk
Annuity Training For Systematic Risk, Active Management, And Indexing
Systematic risk is when the value of your investments decreases over a period of time due to economic factors and changes in the market that impact your investments. Unsystematic risk on the other hand, refers to a possible change in price of your investment due to the changing factors of a specific security, as opposed to the overall economic changes. An annuity specialist can help you reduce systematic risk. Consulting an annuity specialist can be useful because these specialists know how to decrease the risk by diversification or asset allocation. Annuity specialists go through annuity training where they are taught how to manage and decrease risks for their clients.
According to The Handbook of Financial Investments (2002) by Frank J. Fabozzi: For common stocks, several studies suggest that a portfolio size of about 20 randomly selected companies will completely eliminate unsystematic risk leaving only systematic risk (note: the first empirical study of this type was by Wayne Wagner and Sheila Lau, The Effect of Diversification on Risks, Financial Analysts Journal, November-December 1971). In the case of corporate bonds, generally less than 40 corporate issues are needed to eliminate unsystematic risk.
A chart in Fabozzis book shows roughly 60% of total risk is 95% eliminated through the (near 100%) elimination of unsystematic risk. This means that an advisor can eliminate close to 60% of a clients stock market risk by avoiding unsystematic risk.
Active management can be used as a way to reduce risk as well. Active management is a strategy that can be used by an annuity specialist or manager where the goal is to outperform an investment benchmark index by making certain investments. Investors who dont aspire to outperform a benchmark index will usually invest in something known as an index fund which is known as the opposite of active management, passive management. The way an active manager or annuity specialist will go about trying to surpass the index is to exploit market inefficiencies by buying undervalued securities or by underselling overvalued securities.
A 2009 study by Morningstar concludes: while about half of actively managed funds outperformed their respective Morningstar indexes, only 37% did on a risk-, size- and style-adjusted basis. The numbers are similar for five and 10-year returns. Funds that performed in the top 25% over the past three years had much lower risk and volatility than their peers.
Understanding indexing is also important for managers and is discussed in many annuity training courses. According to financial advisor William Thatcher, indexing tends to beat active management in top-performing asset classes and loses to active management in the worst-performing asset classes. Thatcher believes in the best-performing asset classes, index funds are rewarded for purity and active managers are punished for their impurity (many do not stay true to a particular investment style). Results of Thatchers study (1998-2007) show that the benefit of indexing was not consistent over one-year periods. The results of the Thatcher study were consistent with research done in 1999 by advisors Steve Dunn and William Bernstein. Overall, in order to be successful as an advisor or manager, its important to have the proper training and understand the way indexing, active management, and reducing risk works.
Pair Trading (with autotrading) V. 15.6 [ PART I ]
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