Nobel Prize-winning economist Myron Scholes emphasised the need for asset owners to shift their focus from merely measuring risk to actively managing it across different time periods and market conditions. He argued that volatility is not an appropriate measure of risk and highlighted that it’s the downside volatility that investors should be concerned about. Scholes stressed the importance of actively managing risk, even in the short term, as risk over shorter periods compounds into long-term risk. He encouraged moving away from relative measurements and benchmark comparisons to concentrate on compound returns, seeking better ways to measure and manage the compounding effect.
Scholes challenged the conventional view that diversification is the only way to control risk, noting that during times of shock, asset correlations can increase. He suggested that managing downside risk while benefiting from the upside is essential to support compounding and enhance portfolio value. Additionally, he proposed a shift in focus toward understanding the risks associated with compound returns, including both downside and upside risks, and exploring better measurement methods, such as bootstrapping over different timeframes.
The discussion emphasises the significance of a proactive risk management approach, recognising the compounding impact of short-term risks on long-term results. These insights underscore the need for innovative risk assessment and management techniques within the financial sector, particularly for asset owners and managers. Additionally, it highlights the importance of comprehending the expenses linked to organisational operations and the value of assessing returns while factoring in both internal and external costs, contributing to a more holistic evaluation of investment performance.