Investment Risk

Market Risk

Interest Rate Risk

Credit Risk

Manager Risk

Inflation Risk

Currency Risk

Small Capitalization Equity Risk

Derivative Risk

International Investment Risk

Sector Risk

Securities Lending Risk

Substantial Security Holder Risk

Income Trust Risk

Liquidity Risk

What level of risk are you comfortable with?

• Low risk

• Moderate risk

• High risk

What does it mean?

Advisor Interpretation

Client Interpretation

Gap

What maximum drop in value over a one-year period are you comfortable with?

• 0%

• -5%

• -10%

• -15%

• -20%

• Other

You, as well as your clients, will now know how big of a drop in value they can accept.

How can you determine which funds respect your clients’ risk tolerance?

By using the standard deviation and the mean return.

• Measure of variance that defines the risk of an investment by indicating by how much the actual return has varied from the mean return.

• The higher the standard deviation, the higher the volatility. For example:

• Money Market Fund 0,05• Fixed Income Fund 2,93• Balanced Fund 7,11• Canadian Equity Fund 11,87

• How can you tell if the standard deviation is too high for a client?

• We need to know what is the mean return.

Mean return

What maximum drop in value over a one-year period are you comfortable with?

• 0%

• -5%

• -10%

• -15%

• -20%

• Autre

Source: « La relation entre risque et rendement », Objectif Conseiller, juin 2010

Investment Mean Return

Standard Deviation

One standard deviation = 68% of annual returns

(approx. 2 years out of 3)

Two standard deviations = 95% of annual returns

(approx. 19 years out of 20)

A 4.0% 5.0% -1.0% 9.0% -6.0% 14.0%

B 6.0% 10.0% -4.0% 16.0% -14.0% 26.0%

C 8.5% 15.0% -6.5% 23.5% -21.5% 38.5%

D 10.0% 20.0% -10.0% 30.0% -30.0% 50.0%

FundsStandard

deviation last 5 years

Average of rolling one-year returns for the last 5

years

Minimum and maximum annual return based on 2 standard deviations (95% of the data)

Minimum Maximum

Fixed Income 3.07 4.96 -1.18 11.10Harbour Growth & Income

12.15 -1.03 -25.33 23.27

Monthly Income 9.25 5.20 -13.30 23.70

Small Cap. Canadian Equity

22.85 8.29 -37.41 53.99

Source: PalTrak, Morningstar Canada, July 2012 Edition

FundsStandard

deviation last 10 years

Average of rolling one-year returns

for the last 10 years

Minimum and maximum annual return based on 2 standard deviations (95% of the data)

Minimum Maximum

Fixed Income 3.23 4.00 -2.46 10.46Harbour Growth & Income

9.63 4.94 -14.32 24.20

Small Cap. Canadian Equity

18.02 13.95 -22.09 49.99

Source: PalTrak, Morningstar Canada, July 2012 Edition

Such information is available on company websites or on public sites such as

www.globefund.com

Two funds in the same category with similar volatility but a different return.

Two funds from different categories with a similar past performance but a different volatility level.

• The use of the standard deviation and mean return helps in the selection of appropriate funds with regards to a client’s risk tolerance.

• Gives the clients a clearer picture of the potential drops in value and helps prevent selecting investment options that exceed their risk tolerance.

• We recommend that you use at least two standard deviations in your analysis.

• Past performance may not repeat itself.

• In reality, the distribution of rolling one-year returns do not follow a normal distribution.

Possibility of losing money

Possibility of not reaching their financial objective

Starting Point

Objective

Objective not attained

Investor’s Goal Investor’s Risk Tolerance

To reach the goal at a

specific date, the annual

return must be 7%.

The fund that matches the client’s risk

tolerance has an expected annual

return of 4%.

GAP

You should address the gap before making an investment recommendation.

• What does your client prefer?

• A combination of these solutions can be applied.

SSTTEEWW

• Save more

• Take less (smaller goal)

• Earn more (return)

• Wait (reach goal later)

EMOTIONS

They don’t mix well!

Group A

Group B

Group C

Group D

Group E

Most frequent transactions

Less frequent transactions

On average, Group A underperformed Group E by 7% per year.

The Terrance Odean study

PROCRASTINATION

A story about two investors…

Similarities

• Average annual return of 6.00%

• Total amount invested over time: $36,000

Differences

• Investor A:– Investment period from age 30 to age 60– Monthly investment = $100

• Investor B:– Investment period from age 45 to age 60– Monthly investment = $200

A) - Both investors end up with the same market value at age 60.

B) - Investor A will have more money at age 60 than investor B.

C) - Investor A will have more money at age 60 than investor B.

The Big Difference

• Investor A:– Market value at age 60 = $100,451.50

• Investor B:– Market value at age 60 = $58,163.74– To get the same end result as his friend,

Investor B would have to invest $345.41 per month for a total of $62,173.80

Another example with a 6% annual return

Investor A Investor B

Investment Period From age 30 to 45 From age 45 to 60

Monthly Investment $200.00 $200.00

Total Investment $36,000.00 $36,000.00

Market Value at 60 $139,392.79 $58,163.75$

Required Investment to Match Investor A --- $479.31

INFLATION

• The more the goal is long-term, the more impact inflation will have in the plan to reach that goal.

• For retirement plans, since retirement can last many years, inflation can have a devastating effect if it wasn’t taken into account in the plan.

Source: Viewpoint, Lifetime income planning, Fidelity Investments

Indexes 1 year 3 years 5 years 10 years

CPI 1.5% 1.8% 1,7% 2.0%

Average Money Market Funds 0.4% 0.3% 0.9% 1.5%

Average one-year GIC 1.0% 0.8% 1.2% 1.6%

Average five-year GIC 1.7% 1.9% 2.2% 2.7%

• It is true that “secure” investments such as those shown in the table above do not have market risk and very low, or no, volatility (i.e. negative returns).

• However, if the investment return is lower than the inflation rate, it results in a negative net return.

• Inflation is a type of risk that must be accounted for when determining an investment strategy to reach a financial goal.

*Source: PalTrak, Morningstar, July 2012 Edition

• There are many investment risks: some technical, others behavioural in nature.

• It is important to clearly establish clients’ risk tolerance before recommending and implementing an investment strategy.

• Determine if there is a gap between the risk tolerance and the financial goal and help clients make choices that will eliminate this gap.