{"id":1850,"date":"2012-09-13T16:19:33","date_gmt":"2012-09-13T14:19:33","guid":{"rendered":"https:\/\/clusterfamilyoffice.com\/blog\/?p=1850"},"modified":"2012-09-13T16:19:33","modified_gmt":"2012-09-13T14:19:33","slug":"por-que-lo-llaman-riesgo-cuando-quieren-decir-volatilidad","status":"publish","type":"post","link":"https:\/\/clusterfamilyoffice.com\/en\/por-que-lo-llaman-riesgo-cuando-quieren-decir-volatilidad\/","title":{"rendered":"Why do they call it \u2018risk\u2019 when they mean \u2018volatility\u2019?"},"content":{"rendered":"
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\"\"Most of you will no doubt remember the famous Spanish film entitled \u201cWhy do they call it \u2018Love\u2019 when they mean \u2018Sex\u2019?<\/a>\u201d in which Ver\u00f3nica Forqu\u00e9 plays a charming porn actress. We\u2019ve borrowed the title of that film to name this article, in which we\u2019ll attempt to explain the confusion (for want of a better word) that reigns in the financial sector \u2013 that is, amongst banks and their various clients and investors \u2013 when it comes to distinguishing between risk and volatility. To lighten the mood a little, we\u2019ll be interspersing this article with a few cartoons by Forges<\/strong>, who is a master at laying bare the banking sector\u2019s shortcomings.<\/p>\n

In the field of finance, \u201cvolatility\u201d can be defined as a measure of the frequency and intensity of changes in the price of an asset. In other words, the\u00a0amplitude<\/em> and the\u00a0nervousness<\/em> the range of valuation fluctuations that we, as investors, will have to contend with throughout the process of investing, holding and divesting. That is all. For an investor, volatility does not in any way determine the probability of making or losing money on that asset in the long run (risk); rather, it merely indicates the price fluctuations they will have to accept over the life of that investment.<\/p>\n

Let us now define the concept of \u201crisk\u201d for an investor. Any self-respecting investor wants their investments to generate good returns in the medium and long term, whilst being prepared to accept, without fear, that during certain periods in the short term, there may be temporary losses (or gains).\u00a0It is a sort of psychological toll that the investor may have to pay in exchange for a good return at the end of the investment. \u2013 A separate case would be an income-seeking investor who absolutely requires regular returns, even in the very short term.- In this article, therefore, we shall refer to the Investor with a capital \u2018I\u2019\u2014that is, the investor who can withstand substantial short-term losses and fluctuations (volatility), in exchange for their wealth growing adequately over the medium and long term, well above moderate inflation.<\/p>\n

Therefore, the real risk for an investor \u2013 which will significantly hamper the growth of their assets over time \u2013 is limited to suffering irrecoverable losses on some of their investments in the medium to long term, say beyond 3 or 5 years<\/p>\n

On that basis, it should be clear to everyone that the key lies in knowing which investments may generate temporary\/recoverable (volatile) losses and which may incur irrecoverable (risky) losses. Investments that generate losses which are recouped within a few years are those with intrinsic value, where temporary losses are caused by panic, fads and whims in Mr Market\u2019s valuations, but which are not due to a lack of solvency or the ability of the assets in which one has invested to create value.\u00a0Time will set things right; in other words, as weeks, months or a few years pass, the market will eventually align price and value \u2013 provided there is any value, of course. By contrast, investments in companies or fixed-income issues that have lost the solvency and soundness of their respective businesses tend to generate irrecoverable losses over 5, 10 or 20 years, an entire investment lifetime, or even permanently.<\/p>\n

In other words, in the absence of value, there is no reason why the market should ever drive the price up. That is the concept of Risk \u2013 with a capital \u2018R\u2019 \u2013 that we, as investors, must understand and learn to avoid. And volatility is nothing more than a psychological side-effect that we can choose to accept or not, and which has nothing to do with investment risk.<\/p>\n

\"some_text\"<\/p>\n

However, for the banking sector, volatility is everything; it is the key factor to manage. Volatility either brings in or drives away business, in the form of customer retention or customer flight. Long-term profitability, which is directly linked to investment risk, is something that is entirely foreign and irrelevant to bank-employed advisers.<\/p>\n

For investors, on the other hand, the relationship between return and risk (not volatility) is everything, as those who invest do so in the hope of sufficient long-term returns, whilst doing everything in their power to avoid the risk of their investment suffering permanent or long-term losses.\u00a0These are the radically opposing languages of the two groups. And worst of all, it is the bankers who advise and mislead investors\/clients with their surreal language. A language that is, and should be, entirely alien to them, since for investors their bankers\u2019 obsession with volatility must be superfluous; instead, they must focus on something essential that their bankers systematically and fatally overlook and disregard: the measurement of the risk of their investments.\u00a0Because an investor\u2019s time horizon must be much longer than the short-sighted, short-term focus of bankers, who try to survive quarter after quarter by preventing their clients from abandoning them. An investment\u2019s lifespan is almost as long as life itself, and therefore returns must be realised over the course of years, not quarters.<\/p>\n

What good is it to an investor to go 5 or 10 quarters without significant losses, if, after a few years, the purchasing power of their assets has been fatally eroded or they have suffered irrecoverable losses along the way because they focused on volatility and ignored risk?<\/p>\n

Having said all that, you may well be wondering: why do so many \u201cprofessionals\u201d in the sector and so many \u201cinvestors\u201d around the world confuse \u201crisk\u201d with \u201cvolatility\u201d?\u00a0At this point, we must emphasise that the risk to the advising bank should not be confused with the risk to the investor. As is now obvious to almost everyone, in practice, the interests of the bank are not at all aligned with those of its clients; quite the opposite, in fact. And so, when a bank-employed adviser recommends a particular investment to a client, they do so with a view to avoiding risks for the institution they work for and generating profits for it. What are these risks? Well, perhaps the one they are most mindful of when making their recommendations is the risk that the client might switch banks in the short term, thereby cutting off the flow of profits to the bank. In other words, they must keep the client as happy as possible whilst the employee is still managing their account \u2013 which is not usually for very long, given the staff rotation and promotion policies typically implemented by banks.<\/p>\n

In the long term, they don\u2019t care if customers switch to the competition, as their business vision is just as short-sighted as that of politicians, who cannot see beyond the next election. It is even common for the employee themselves to switch banks in the medium term and try to take as many customers with them as possible (doing a complete U-turn, that is, speaking ill of their former bank and singing the praises of the new one without the slightest hint of embarrassment).<\/p>\n

The bank will therefore recommend investments to its customers that meet these requirements, in the following order:<\/p>\n

    \n
  1. The investment should generate the highest possible commission or profit for the bank.<\/li>\n
  2. To ensure that the customer can sign all the necessary documentation to prevent them from successfully bringing any future legal action or claim against the bank (this is why the MiFID regulations were created, and not to protect the investor).<\/li>\n
  3. That will allow him to sleep soundly for the time being\u00a0suffering<\/del> both to attract and retain customers. The bank does not care whether, in the long term, the customer will permanently gain or lose money (in other words, whether they are at risk or not), whether their wealth will grow adequately or whether it will be eroded by inflation, for example (remember that the \u2018long term\u2019 is a concept that does not exist in banking).<\/li>\n<\/ol>\n

    To meet this third requirement of not disturbing the sleep of their\u00a0faithful<\/em>, the concept that the bank adviser must grasp is that of \u201cvolatility\u201d, even though he may sell it to his loyal clients as \u201crisk management\u201d (which sounds more impressive). Because according to the unwritten code of bankers and part of the financial sector in general,\u201cA customer may be willing to accept winning slightly less than their friends or acquaintances, but they will never accept losing more.\u201d<\/em> In other words, you can keep him on by condemning him to the most utter mediocrity without the slightest qualms, but if the volatility keeps him awake at night and he\u2019s exposed in front of the herd, he\u2019ll inevitably head off to the competition.<\/p>\n

    That is why the factor banks use to prevent a customer from getting fed up and leaving is that the more afraid a customer is of losing money in the short term (which they label a \u201cconservative profile\u201d), the less volatility they should have to put up with. The thing is, this approach isn\u2019t sold to the customer as a low-volatility investment but as a low-risk one, thereby confusing them and leading them to confuse \u201crisk\u201d with \u201cvolatility\u201d.Why? Well, because most customers (who are not experts in the field) want to hear the magic phrases: \u201cNo risk\u201d, \u201clow risk\u201d, \u201csafe\u201d, \u201cvery safe\u201d, \u201cconservative\u201d and other euphemisms which, for the bank, translate into a\u00a0\u201cSleep soundly and don\u2019t switch banks\u201d<\/em>. It doesn\u2019t matter whether, in the long run, it\u2019s eaten away by inflation, an irrecoverable loss, or whether your money has simply been used to pay commissions left, right and centre. In this way, the bank simply ensures that its portfolio does not suffer any significant short-term losses, which would jeopardise (and that\u2019s when they really do care about this concept) the customer\u2019s continued business.<\/p>\n

    \"some_text\"<\/p>\n

    That\u2019s right, it is probably also the bankers\u2019 subconscious that betrays them, causing them to confuse the customer\u2019s risk (of permanent losses on their investment) with their own risk as bankers or bank employees \u2013 that is, the risk to the bank itself that the customer might switch to a rival bank across the street.<\/p>\n

    And to minimise the risk of clients leaving them, they limit the volatility of the investments they place on their behalf, ignorantly or maliciously confusing (customer) volatility with (bank) risk<\/strong>. That is why clients are sold a low-risk investment when, in reality, the only thing that is low-risk is the chance of the client switching to a competitor, due to the low volatility that investment will exhibit in the short term<\/strong>. And what they should explain to the client is that this investment is characterised by low volatility, which does nothing to clarify the risk involved \u2013 that is, the likelihood that the client will suffer irrecoverable losses over time<\/strong>.<\/p>\n

    As an example, we could cite any of the so-called \u201cpatriotic\u201d bonds, such as those issued by thebonds issued by the Catalan Government<\/strong>. Since their issue, these investments have been characterised by very low volatility for investors; however, if they are to avoid default (non-payment\/bankruptcy), they will have to be bailed out by the Spanish State, which in turn will also have to be bailed out by the European Union and the ECB. In short, this entails assuming a considerable risk of permanent loss, regardless of whether or not the venture ends well in the coming months.<\/p>\n

    It goes without saying that the banks have sold \u2013 and continue to sell \u2013 these low-volatility investments, either naively or maliciously, as investments that are practically \u201crisk-free\u201d\u2026 in return, of course, for extremely lucrative placement fees paid generously by the regional government issuing them in a desperate bid to raise funds.\u00a0The fact is that an insolvent asset can remain relatively stable for years\u2026 until its underlying problems become apparent to the market; by which time, when volatility skyrockets, it is already too late to avoid a definitive loss<\/strong>. That could be the grim consequence of focusing exclusively on volatility whilst ignoring the risk involved in an investment. And today, that risk is more prevalent than ever in this \u2018New Normal\u2019, which coexists with a saturation of debt across the developed world, given that fixed-income assets \u2013 despite their still moderate volatility \u2013 are now less \u2018fixed\u2019 than ever due to their insolvency.<\/p>\n

    But that\u2019s not the end of the story, because when risks materialise and losses are incurred, investors have to put up with the fact that the banks\u00a0voices are raised <\/a>blaming its customers for the poor results, citing their interference in the management. That\u2019s a bit rich.<\/p>\n

    Thus, the financial sector in general \u2013 and the banking sector in particular \u2013 has lost its way to such an extent that it has ended up completely disregarding the concept of risk for the investor. What we defined in the third paragraph of this article as \u201crisk\u201d from the investor\u2019s point of view is complete gibberish in banking parlance, as the sector cannot see beyond its own commercial interests.\u00a0In other words, it ignores everything other than the (dubious) tactics used to keep its customers captive. And to this end, its only tool is the control and allocation of greater or lesser volatility within its clients\u2019 portfolios, depending on the depth or lightness of their sleep \u2013 or, worse still, the greater or lesser ease with which they can be deceived. I recommend that all investors read the article entitled\u00a0\u201cVolatility prevents us from seeing the wood for the trees\u201d<\/a>.<\/strong><\/p>\n

    The ability of investments to generate returns\u00a0in the long term<\/strong> The fact that they outperform their respective benchmarks is of no concern whatsoever to bank advisers. They believe they have enough on their hands simply determining and assigning appropriate volatility levels on a quarter-by-quarter basis to each client profile, and reconciling this with a range of investments that are highly profitable for the bank.<\/p>\n

    It never even crosses their minds that they should also consider whether these investments carry a higher or lower level of risk for the customer and, over time, generate greater or lesser returns. Unfortunately, that is not what the banking sector is for. It exists to retain and exploit its customers efficiently in the interests of the institution. And, sadly, investors have been systematically misled and misinformed to such an extent that they accept as normal the fact that their bankers fleece them with mediocre, low-volatility investments, selling them off as the options best suited to their \u201crisk profile\u201d once they\u2019ve signed on the dotted line, albeit after signing a mountain of unintelligible paperwork that will legally cover up their failings as advisers should any client ever wake up to the reality.<\/p>\n<\/div>\n<\/div>","protected":false},"excerpt":{"rendered":"

    La mayor\u00eda tendr\u00e9is en la memoria la famosa pel\u00edcula espa\u00f1ola titulada \u201c\u00bfPor qu\u00e9 lo llaman Amor cuando quieren decir Sexo?\u201d en la que Ver\u00f3nica Forqu\u00e9 encarna a una entra\u00f1able actriz porno. El t\u00edtulo de dicha pel\u00edcula nos ha servido para dar nombre a este art\u00edculo donde trataremos de explicar la confusi\u00f3n (por llamarlo de alguna […]<\/p>\n","protected":false},"author":6,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[54,51,39,40,52,37,48,56],"tags":[],"class_list":["post-1850","post","type-post","status-publish","format-standard","hentry","category-asesoramiento-patrimonial-deportistas-artistas","category-banca","category-crear-mi-propio-family-offices","category-gestion-financiera","category-asesoramiento-patrimonial-multi-family-office","category-reflexion","category-asesoramiento-patrimonial-multi-family-office-crear-mi-propio-family-offices","category-que-es-un-family-office"],"_links":{"self":[{"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/posts\/1850","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/users\/6"}],"replies":[{"embeddable":true,"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/comments?post=1850"}],"version-history":[{"count":0,"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/posts\/1850\/revisions"}],"wp:attachment":[{"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/media?parent=1850"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/categories?post=1850"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/clusterfamilyoffice.com\/en\/wp-json\/wp\/v2\/tags?post=1850"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}