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To say the Financial community love labels in an understatement. There are acronyms for acronyms and investments, based on these acronyms, are sorted into even more acronyms to assess suitability for groups of investors, themselves classified by acronyms. As an industry we have enough cyphers to fill a periodic table – see below! – and yet the question remains do any of these terms actually help when it comes to making an investment decision? Do these labels help us or, instead, do they simply make our lives more complicated?

Take risk as an example. It was not too long ago that Government bonds were labeled ‘risk free assets’. This however now seems completely out of line with the following recent statement from industry titan Pail Singer, founder of Elliot Management, who warns investors, “Hold such instruments at your own risk; danger of serious injury or death to your capital!” If government bonds are the new ‘high risk asset’ what then does this mean for early stage equity funding – an asset class typically deemed among the highest risk of them all?

There is no disputing that investments in early stage companies are not suitable for everyone. Angels understand that they are backing young companies with little by way of track record and no liquidity. The potential rewards however are highly attractive. 10yr UK Government bonds are currently yielding under 1% which by comparison makes the government’s generous SEIS/EIS schemes look incredibly appealing. To put some numbers around it – if you are a higher tax rate payer with a portfolio of EIS investments who claims all possible tax reliefs you are able to make just over 7% pa compounded over 5 years even if your capital drops by a corresponding 5% pa.

Yes, these investments will be illiquid, volatile and carry high risk, but if constructed as part of a carefully selected portfolio and properly managed over 5, 10, or even 15 years, should you worry unduly about near term liquidity and volatility? This is where the problem of labels kicks in. When you talk to an adviser about making an allocation shift towards smaller companies, you will be hit by a myriad of warning labels; ‘high risk’, ‘illiquid’, ‘total loss of capital’! You are then faced with a tough choice – remain in what are deemed safe assets at the expense of growth, or, take what is considered the riskier path. Are you willing to go against consensus and make a call that could go wrong? In 2007 you could have swum with the school and owned low risk CDOs labelled ‘A’ by US rating agencies and still have lost most if not all of your money. When funds are parked in a specific asset for the wrong reasons there can be a painful rush to the door when this reason proves false.

If we are in a new financial paradigm where rates are to remain low for an extended period, then our labels of risk also have to change. At its most basic level the value of a company is the present value of future cash flows. The discount rate you use is the ‘risk free rate’ (the government bond rate) with an additional equity risk premium. 10 years ago this risk free rate was roughly 5%. Therefore, not that long ago a ‘low risk’ labelled portfolio would have held government bonds with an implied 5% risk. Equities, with their additional risk premium, were closer to 10%. Today government bonds yield effectively nothing so the equity risk has also fallen to around 5% - the level that government bonds used to be. Why therefore have our labels of risk in portfolio allocation remained unchanged?

What it all comes back to is you - the individual Investor; understanding what your needs are and what risks – not labels – you are comfortable taking weighed against the potential reward. This is not to say that an individual, without advice, should make drastic allocation shifts in their portfolio. Instead they should engage with their advisers and challenge labels that may no longer reflect what they once did. All investment carries risk and risk profiles can change very rapidly, by comparison investment ‘labels’ rarely change at all. What would you rather do - make investments based on researched and calculated risk /reward decisions or simply allocate your funds using outdated ‘labels’?

To help navigate the murky waters this periodic table of alternative investments should help!

https://coinvestor.co.uk/media/pdf/CoInvestor_Periodic_Table.pdf