Book Review > The rules of Risk: A guide for Investors

The beginning of this book gives the reader a plethora of examples of situations that turned to Regret because the Risk/Return factor was not taken into account. The authors define risk as: (quote) "Risk is a measure of the potential changes in value that will be experienced in a portfolio as a result of differences in the environment between now and some future point in time."

For forward-looking risk management, four elements are examined: Time Horizon; Scenarios; Risk Measure; and Benchmarks.

The Time Horizon is important because different investment vehicles have different optimum time horizons. Scenarios are powerful tools for reducing the uncertainty we face looking forward. Without scenarios on the future it is impossible to develop a coherent framework for risk management. This text shows how using a few "what if?" scenarios can lead us to adopt investment tactics that manage risk. The authors "pan" a measure of risk used by businesses termed Value at Risk (VaR), because the measure is too simplistic.

Benchmarks like the S&P500, the ASX 300, or the NASDAQ can give a crude market measure. If you were contemplating buying say shares in a sector like health, telcos, retail; average figures for those sectors usefully benchmark against a particular purchase. Probability based decision making is derived from an average of many occurrences. It is used a lot by businesses today, but as the authors point out, most decisions one-time only. Variability, variance and volatility are described as is the "risk aversion constant" (» Lambda).

The shortcomings of using EVA (Economic Value Added) solely, to judge a company�s performance are detailed here. An enhanced measure of risk adjusted EVA is suggested as being more useful. (RAP) Risk adjusted performance is examined particularly as applied to Mutual funds. The traps to using this measure are highlighted. Very interesting and startling results are produced when M2 measure based on the Miller-Modigliani theorem. Firms can alter their debt to equity ratio to adopt a particular risk profile. Some examples show how Funds can be leverage in the same way to comply with a particular risk benchmark. The final chapter summarises the approach to risk by providing useful six rules to use. I think that the application of these rules will cause many of us to "weed" out the more risky investments in our portfolios while maintaining expected returns.

I found this book was not an easy read and even after three times through there are still parts I�ll need to read again. The book read more like an academic text for those in this field. New concepts were often introduced "in passing" and had to be "teased out" of the text. The information was very good however, with plenty of life examples presented (a particular strength), but the manuscript could have done with more packaging into "bite sized chunks" for the general reader/investor.