Market Beat: Risk can take many different forms
August 5, 2014
Paul Singer, the manager of the $24.8 billion hedge fund Elliott Management, recently sent a letter to his clients warning them about potential EMP risk.
Investing involves risk and risk can take on many different forms. Those risks can be managed in a variety of ways. The risk of one stock performing poorly, known as company-specific risk, can be mitigated through diversification.
The risk of the entire stock market declining, known as systematic risk, can be diversified away by investing in asset classes that have a low correlation to the stock market like US Treasury bonds.
Fixed-income investments are subject to interest rate risk. As interest rates rise, the prices of bonds falls — it's an inverse relationship.
Inflation risk means that your long term investments may not keep pace with inflation, and you could lose your purchasing power over time.
If you choose to invest very conservatively, like with banks savings accounts, short term CDs or Treasury bills, you shouldn't lose principal because those investments are FDIC insured or backed by the full faith and credit of the United States government.
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But if the inflation rate exceeds the rate of return on your investments, your dollars will not be able to buy as much in the future.
Some types of risk, including geo-political risk and natural disaster risk, can be very unpredictable and can have a serious impact on global economies and markets. Geo-political risk can evolve rapidly as wars can escalate and impact global trade.
Natural disasters like volcanos, earthquakes and tsunamis occur with regularity and can also have an impact on the local economies. Even something extreme like a major asteroid strike could occur again.
So what is the EMP risk that Singer has warned his clients about? EMP stands for electromagnetic pulse, and one could occur naturally or be man caused from a high altitude nuclear explosion.
According to an article in CNBC, a naturally occurring EMP event could cause massive damage to the power grid and shut it down completely for several months.
The consequences of an event like that could be difficult to imagine. Singer warned his clients that a man-made EMP attack could be worse than a natural one.
I don't think I'll stay up at night worrying about a pending EMP event, but we do live in a world full of risk, and investors should be aware of the different types of risk and know their own personal risk tolerance.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.
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