Overview of Andes Risk Score
Many people prefer a 0–100 risk score because it is intuitive and easy to understand. There is a simple way to derive this scale.
Within the Andes Risk platform, a risk score is calculated by multiplying a portfolio’s volatility (standard deviation) by 5, resulting in a score that typically falls between 0 and 100. For example, a 100% equity portfolio usually has a volatility below 20, which translates to a risk score close to 100 when multiplied by five.
In some cases, the risk score may exceed 100 for very high-risk investments or during periods of market turbulence. For instance, Bitcoin’s risk score can surpass 100. The article How Risky Is Bitcoin? explains this methodology in more detail.
The risk score can also be used to quantify an investor’s risk tolerance, as our patented Risk Tolerance Test maps the investor’s selection directly to one of the advisor’s models.
Assigning a Risk Score to a Model
A model’s Risk Score is calculated by multiplying its volatility by five, using either long-term historical volatility or the model’s target volatility.
Below are the capital market assumptions for a 60/40 Model. The model has a target return of 6.30 and a target volatility of 11.90. The Risk Score is calculated by multiplying the target volatility by 5 (11.90 × 5 = 59.5), which is then rounded to the nearest whole number, resulting in a Risk Score of 60.
Assigning a Risk Tolerance Score to Investor
The Andes Risk Tolerance Test presents the potential upside and downside of a range of models spanning the full risk spectrum, from conservative to aggressive. When an investor selects one, it maps directly to one of the advisor’s models. As a result, the model’s risk score is assigned as the investor’s risk tolerance score.
In the image below, the client indicates comfort with a 70/30 model. Since this model has a risk score of 70, that score becomes the investor’s risk tolerance score.
Portfolio Comparison
Portfolio Accounts Overview [Navigate to Dashboard → Portfolio → Portfolio Accounts, Overview tab], compares the portfolio with the Target Asset Allocation. In the example below, the current account portfolio of the client has a risk score of 70 while the Target Asset Allocation has 60.
It’s important to note that a portfolio’s risk cannot be fully captured by a single number, as short-term volatility can differ significantly from long-term volatility. When evaluating a prospect’s portfolio, a 10-year time period is often used.
Why Portfolio Risk Can’t Be Captured by a Single Risk Score?
This section demonstrates how portfolio risk can look very different over short-term versus long-term periods. As a result, portfolio risk cannot be fully captured by a single risk score, but rather by a set of risk scores—each representing risk over a specific time horizon.
The chart below shows the efficient frontier based on the capital market assumptions of the models. For example, the 60/40 model has a risk score of 59, which reflects how the model is expected to behave under normal conditions.
In practice, models do not always behave as expected—especially during periods of market turmoil. For instance, during the 3-month period ending 2020/03/23, the risk score rose to 158, reflecting the significant increase in risk during that time.
However, when looking at the 10-year period ending 2020/03/23, the risk remained within the expected range.
This highlights why portfolio risk cannot be accurately summarized by a single number. Short-term and long-term risks can differ substantially. During periods of market stress, short-term risk may spike, even though the long-term trajectory of the portfolio remains intact. Investors with a long-term investment horizon are generally advised to stay invested despite short-term volatility.
Conclusion
In conclusion, Andes’ risk methodology uses volatility as a practical and comprehensive way to evaluate portfolio risk. By translating volatility into intuitive risk scores, Andes enables advisors and clients to better understand risk and make informed investment decisions with confidence.