Finweek English Edition - - COMPANIES & INVESTMENTS -

Un­der CAPM, there is only one type of risk – ‘mar­ket’ or sys­tem­atic risk – which is not di­ver­si­fi­able. You can out­per­form dur­ing a bull mar­ket if you have a high beta to the mar­ket. In this case, the riskad­justed re­turn should be pe­nalised as the out­per­for­mance is due to ex­cess mar­ket risk. Sim­i­larly, a low beta port­fo­lio should be given credit for lower mar­ket risk ex­po­sures.

Given the above CAPM def­i­ni­tion, there is a more mod­ern view of risk. It is now widely ac­cepted that there are two cat­e­gories or qual­i­ties of risk. There are l ow- qualit y r i sk f ac­tors which a re unavoid­able but ex­plain the vari­abil­ity in our port­fo­lio ret urns. Th­ese would in­clude in­ter­est rate risk, credit risk, cur­rency risk, sec­tor risk etc. They are called low-qual­ity risks be­cause you don’t get any­thing in re­turn for tak­ing on th­ese risks. They just add unavoid­able volatil­ity to your port­fo­lio.

Then there are high-qual­ity risks which com­pen­sate us for tak­ing on ad­di­tional risk to gen­eral mar­ket risk. For ex­am­ple, ‘value-risk’ is seen as a worth­while risk be­cause, by buy­ing low-PE stocks with a high div­i­dend yield, we earn an ex­cess re­turn to the mar­ket over time (also known as the value risk-pre­mium).

Other well doc­u­mented risks that pro­vide ex­cess re­turns in­clude small-cap and mo­men­tum risk-pre­mia. All of th­ese risks on aver­age, over the long-run, pro­vide us with ex­cess ret urn but with

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