ONE of the most glaring omissions in investment- type advertising material and stockbroking reports is a proper risk assessment to accompany the potential returns on offer. Why is this so? Investing is, after all, a two-dimensional affair that involves balancing risk against rewards, yet in almost all areas of finance, very little regard is given to risk. Instead, we almost always only see impressive headline numbers trumpeting large potential profits with no or little mention of possible risks. Surely it's time some governing authority looked at changing this?

Take a look at a typical advertisement for a fund or unit trust. The usual format is to show the public the track record of the fund manager in terms of percentage returns generated over various time frames, usually one year, three years, five years and sometimes even over 10 years.

There is always an accompanying public relations-type write up about how superior the fund is, how it might use rigorous fundamental, bottom-up selection to screen its stocks and always fine print about how past performance is no guarantee of the future. The bottom line? 'Put your money with us because we are a proven force in the investment community. Even though we can't guarantee that we'll make as much money as we did in the past, rest assured that we're good at what we do.'

All of this is fine but how good is good? How can anyone claim superior performance if risk is not factored in or disclosed? There is almost always no indication of how much risk the fund or its managers took on before it earned the advertised returns. Surely this is a crucial omission in a disclosure-based regime based on providing as much relevant information to the public in order for the latter to make proper investment decisions?

Finance theory tells us that risk is measured by the variability of returns. So a stock with greater variability (or volatility) is deemed to be more risky than one with smaller variability. This is measured using standard deviation or variance found in statistics. The point is that if returns can be quantified so can risk, yet the finance world never discloses this - even though it must surely be useful information.

If, for example, there are two or more funds offering exposure to a particular market whose managers have similar track records. Surely the decision to choose one over the other would then rest on which manager achieved its performance by taking on less risk?

The same non-disclosure of risk is also to be found in most broking research. Granted, brokers are in the business of selling stories, generating ideas and, more often than not, getting clients to buy. So you'd be hard-pressed to get them to present both sides of the investment coin since a detailed risk analysis might discourage buying.

But if one accepts that like fund managers, brokers owe a fiduciary duty to their customers (the dictionary defines 'fiduciary' as of or having the nature of a trust) then it must be that risk plays an equal part in any research or material that is prepared in order to induce the public to buy.

To be fair, some brokers have a risk rating system that rates their recommendations according to whether it is low, medium or high risk. This, however, is not a universal practice and only appears in the minority of reports.

The problem, of course, is that because a proper risk assessment has traditionally not been included in investment material, the public has grown used to it not being there.

On top of this, investors have had their attention diverted by clever advertising that forces them to focus on eye-catching returns, to the point that risk is usually glossed over or even forgotten.

Perhaps it is time to change this. The correct approach in a disclosure-based regime is to empower investors to make informed decisions about where to place their money. In this respect, balancing risk disclosures - especially when it comes to apparently superior past performance - with returns information must surely represent a logical step forward.

This article was first published in The Business Times on May 6, 2008

Is this article useful to you?