Risk Adjusted Performance Target
While pursuing a risk-adjusted performance target fund managers have to arrive at investment strategies and risk management strategies concurrently. Fund managers have to follow a policy that encompasses a level of diversification, leverage, selection of securities that are compatible with the objectives of investors and their own forecasts. Fund managers need to clearly state the quality of assets that they are going to invest in to prospective investors. This will indicate the volatility of returns. The degree of gearing of risky assets and diversification will decide the level of risk in the portfolio. A greater level of diversification or a portfolio with more independent securities helps reduce the total level of risk by averaging out independent risks.
When we allocate funds to a risky asset class relative to a risk free asset class, typically using cash deposits or borrowings to invest in the risky asset class than the equity value of the fund is called gearing up or leveraging. The expected return above the risk free rate and the volatility of return vary proportionately. Investors look for both attributes in tier search for a well-defined fund. Fund managers use heuristics to constantly balance their portfolios. They arrive at these by trial and error that combine objectives of profit with risk minimization. (Stop losses, delta limits, limits on turnover). Fund managers using systematic re-balancing rules use highly quantitative investment strategies.