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When investors want to minimise the risk of their investment portfolio, this essentially means that they want to minimise the stress involved with investing. This stress is not a result of experiencing high volatility or high theoretical VaR or CVaR values in a portfolio, but rather simply a result of losing money. Our iVaR portfolio construction framework aims to minimise this stress, which has important advantages for both investors and their portfolio managers/advisors.

Traditionally, risk measures such as volatility have been used in the past because of their simple mathematical properties. But that’s not how humans perceive risk. They think of it in terms of depth of loss (drawdown), frequency of losses, and time to recovery.

Our innovative risk measure, InvestSuite Value at Risk (iVaR), was built on the premise that any instrument or portfolio providing strict monotonic growth (i.e. no losses) should be riskless, regardless of the speed or consistency of the growth. This matches the behaviour of a cash savings account, which also increases monotonically in value over time, and is considered riskless by end investors.

We calculate the risk (“iVaR”) as the deviation from monotonic growth. It is the sum of the red areas in the chart below, which combines the size of the losses (the height of the red areas) and the time it takes to make up for them (the width of the red areas).

The objective of our portfolio construction framework is to minimise the frequency, the magnitude and the duration of drawdowns; in other words, the goal is to minimise the iVaR value.

This 4th generation risk-measure can also be used to define relative risk versus a benchmark or index, similar to how volatility can be used to define relative risk via tracking error.

Using this risk measure in portfolio construction should lead to portfolios that suffer lower losses (versus a benchmark) and make up those losses more quickly, compared to traditional risk measures.

It can be observed that the maximum drawdown for the InvestSuite portfolio construction framework is about 28%, while the value is around 60% for the EuroStoxx 50 TRI. Even more importantly, drawdowns larger than 15% are consistently more frequent for the EuroStoxx 50 TRI.

Because the InvestSuite portfolio construction framework aims to minimise the frequency, the magnitude and the duration of drawdowns, it is a natural consequence that smaller % drawdowns are more frequent for the iVaR portfolio construction approach than for the EuroStoxx 50 TRI. However, the effect of this concentration in smaller % drawdowns has no severe consequences, because larger % drawdowns are consistently reduced in frequency and duration.

Over time, iVaR should enable a smoother-ride for investor’s portfolio when compared to traditional risk measures and portfolio construction methodologies.