When risk rises, stick to the plan

Times are getting tough in investment markets, at least depending on where you look. Whether it was the hundreds of billions of dollars of value lost from the big US tech stocks with the emergence from deep-left-field of DeepSeek AI – on the basis of its unconfirmed claim that it could disrupt the generative AI industry, having developed its AI model at a fraction of the cost of Western competitors, with low-grade semiconductors – to the growing velocity of company and investment defaults in the lending sector, there seems to be more potential risk than ever before, everywhere you look.

The S&P500 continues to trade at levels that would historically be viewed as being ‘significantly overvalued,’ at 25 times forward earnings, but does this even have relevance in an environment where companies no longer own physical assets? Nor where they continued to grow in the teens despite being several decades old.

Among the biggest challenges faced by advisers is keeping clients aligned with their long-term investment approach during difficult periods. Central to this challenge is the need for advisers to appropriately assess risk, both to their business and their clients.

We know from clients that risk isn’t about volatility, and how much share markets move in any given week, it’s about the permanent loss of capital. This is particularly relevant for those in retirement, with a now-finite pool of capital required to last their entire lives.

The days of pursuing risk in the search for income are long gone, with a return to ‘normal’ interest rate settings offering an abundance of low-risk opportunities for investors. But have advisers and investors kept up with this trend?

One area that is receiving growing focus and its own share of headlines is private credit. Private credit refers to those non-banks that are providing loans to borrowers to whom the banks would prefer not to lend, for one reason or another. This kind of debt is an attractive investment, offering contracted (albeit not guaranteed) income, and the return of your capital, with higher rates making the asset class ever-more-attractive.

The challenge, of course, is when things start to go wrong. In recent weeks, confirmed by the growth in administrations and bankruptcies, a number of high-profile defaults have placed the spotlight firmly back on the risk-return equation. The major drawback of debt is that it relies solely on your borrower’s solvency to be able to pay you the contracted interest.

Knowing to whom you are lending, and by what are your loans being secured, is central to ensuring you are receiving an adequate return for the risk you are taking. It only takes a small number of defaults in a loan book to wipe-out an entire year’s worth of income. And the story is the same in share markets; loading-up on a single company, or just a few, and hoping things will continue to go to plan, is an increasingly high-risk strategy.

At times like these, the role of financial advisers becomes even more important. Advisers must not only understand how each individual client responds to losses, but they must also have the knowledge to assess the true risk of the investments they are recommending, which isn’t getting easier.

Am I taking equity risk, or debt risk with this investment? What happens if things go wrong? What income should I be getting paid for this level of risk? What happens if the ‘Magnificent 7’ turn into the ‘Lagnificent 7?’

These are just a few of the questions advisers and investors must be asking themselves every single day, in an environment where there is no shortage of opportunities, both new and old. Having sound frameworks and a well-considered plan is the only way to navigate this type of environment.

Drew Meredith

Drew is editor of The Inside Network's publications and a principal adviser at Wattle Partners.