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UNDERSTANDING RISK WHEN INVESTING AND HOW TO LIMIT IT

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By Ben Hobson, Markets Editor, Stockopedia

 

Most investors know the age-old saying that with great risk comes great reward. But in the stock market, excessive risk can end in painful losses. Managing the biggest risks with a balanced, well-diversified portfolio can deliver more consistent returns, and, crucially, help you sleep at night.

When it comes to investing your own money – and potentially losing it – there are uncertainties at every turn. It could be a market collapse, a badly chosen stock or a poor decision made in haste. But the risk of getting things wrong can be managed.

With so many variables at play, Ben Hobson, Markets Editor at investing platform Stockopedia.com, shares his insights on ways of evaluating risk and how to manage it for better returns.

 

Understanding risk

Warren Buffett, one of the world’s richest investors, describes risk in simple terms. For him, it’s all about the chance of permanently losing capital. Or, to a lesser extent, just not making a good enough return on an investment that he’s made.

Whether you’re a billionaire or new to the stock market (or somewhere in between), Buffett’s words ring true. The nuts and bolts of risk are really about the chances of losing money. And never is that peril higher than when markets become bullish and investor exuberance gets carried away.

We saw an interesting example of this recently involving the US company GameStop, which saw its share price soar and then collapse.

A battle of wills between rebellious traders on Reddit and hedge funds traders on Wall Street, probably caught out many naive investors. A lot of them will now be wondering how and why they lost so much money.

These kinds of events – and the fear of the damage that bad risks can do – is the reason why academics have spent years figuring out how to measure risk. When you hear about risk today, it’s often couched in terms like volatility and correlation.

These concepts don’t define what risk is, but they can be useful. They can help you think about how an individual share tends to move around its average price over time, and how different shares tend to move in relation to one another.

These ideas are important because they can guide you on how a share might impact your portfolio. Mixing and matching different types of shares can then help to achieve some balance across your holdings.

Add to that other factors like personal risk appetite, your investing timescale, income, goals and different investment allocation… and it’s possible to construct a picture of what a dependable stock market portfolio might include.

 

How to limit risk and make your money work harder

Diversifying a portfolio is one way of making money work harder while cushioning the impact of risk.

It can be tackled in different ways. It might mean mixing small, mid and large-cap stocks. After all, small, fast-growing companies can produce stunning profits in buoyant conditions. But smaller firms also carry more idiosyncratic risk, which can make them vulnerable. Larger companies can be better at fending off the impact of market shocks, but their growth rates tend not to be that high.

You can also spread risk by investing across so-called “super sectors”: Cyclicals, Defensives and Sensitives. Cyclical sectors are generally more attuned to macro trends and the health of the economy and consumer confidence.

By contrast, Defensives sell goods that we buy in good times and bad. They include drug companies and utility groups. In between are the Sensitives, which move with the economy but not as much as Cyclicals do.

Another way of thinking about diversification is to consider buying into foreign markets. The London Stock Exchange only accounts for around eight percent of global stocks. And while the FTSE 350 does have some natural foreign exposure, a truly diversified world portfolio would theoretically include more than 90 percent in foreign holdings.

A fourth diversification option is to hold stocks with different levels of historic volatility. Periods of high and low price volatility are cyclical. In calm conditions it’s the higher volatility stocks that catch the eye of investors. Yet research shows that it’s the cheaper, less volatile stocks that actually often outperform everything else over time.

Many investors watching recent headlines will have been bewildered by what they saw. It was a snapshot of behaviour that really only happens when confidence and willingness to invest with little care about risk, is sky high.

At a time when the economic conditions remain so uncertain, risk management with the help of diversification can offer some protection – and help you sleep at night – when others in the market are losing their heads.

 

Technology

BIOMETRICS: BALANCING SECURITY WITH CONVENIENCE

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Jean Fang, Authentication Product Manager and Joël Di Manno, Authentication and Biometrics Laboratory Service Line Manager at Fime

 

From a person’s face to their iris, voice or fingerprint, biometric solutions are giving us new ways to authenticate ourselves when using a device or making a payment. Research suggests that the global facial recognition market alone will be worth up to $13.87 billion by 2028, with other modes of authentication following a similar growth pattern.

The trend towards biometric authentication has been further accelerated by the global pandemic. Hygienic touchless identification solutions have become critically important. And, with customers already familiar with using biometric solutions on their phones, the growth of this industry only looks to continue. In this blog we will evaluate this growth and discuss some of the potential opportunities and challenges that lie ahead.

 

Addressing fragmentation

Biometric authentication is an innovative and rapidly evolving technology. However, the speed with which it has developed brings with it unique challenges. The technology operates within a largely non-standardized ecosystem, meaning that it is fragmented on many fundamental issues. Little regulates how manufacturers and developers create and implement solutions.

The fragmentation that currently exists means that developers and manufacturers face three main challenges:

  • Increasing interoperability and adaptability.
  • Looking for a standardized certification process.
  • Formulating uniform benchmarking practices to allow developers to compare key performance metrics.

Addressing these three concerns will help create a simpler, more standardized biometrics ecosystem, allowing innovations to reach the market quicker and cheaper.

 

Security vs UX

The most notable emerging use cases for biometrics are payment authentication, access control and government administrative projects. All three require access to extremely personal data, and therefore it is essential for them to have very strong security.

Perhaps the major selling point of biometric solutions is their ability to provide the necessary security while enhancing the user experience (UX). However, overly-stringent security can negatively impact the UX. Therefore, there must be a trade-off between the two.

The best way to understand this balance is by comparing the False Acceptance Rate (FAR) with the False Rejection Rate (FRR). A low FAR gives a good indication that a solution is secure, as it only accepts the right user. Meanwhile, a high FRR provides a very high level of security, but creates friction – and potentially damages the UX – as it prevents genuine individuals from authenticating. Striking the right balance between these two is crucial to maintaining high security standards without creating a poor UX.

 

Multiple modalities for multiple solutions

The adaptability of biometric solutions means that original equipment manufacturers (OEMs) must constantly evaluate the available solutions and determine which is the best for their device. OEMs must develop a clear strategy to determine which biometric modality is best suited, factoring in cost, UX, speed and security.

However, there are also situations where device manufacturers may want to utilize multiple modalities. This can benefit both the UX and security of their solution, as it can address numerous concerns:

  • It can account for environmental concerns. For example, if a user is wearing gloves due to cold weather, making fingerprint scanning impossible, authentication can be achieved another way.
  • For high-risk authentications, multiple modalities can be utilized at once to achieve heightened security.
  • It also allows for adaptability regarding any future changes to the industry or regulatory requirements.

Determining which modalities will best serve a device and its deployment is one of the major challenges OEMs and developers face. The current lack of standardization only further complicates this. However, as the field grows and becomes less fragmented, the multimodality of biometric solutions will facilitate innovation and security for years to come.

 

Just the beginning

Biometrics have become a fixture of consumers’ everyday lives, but the huge successes seen in mobile technologies have not yet translated to other sectors. Innovations continue to push the boundaries of how we use biometrics, as they are rolled out in workplaces, homes and transportation. To reach widespread adoption, companies need to provide customers with assurance that their products are secure. Standardized testing and certification lay the foundations for this.

Biometric technologies continue to evolve daily, which means that the regulations and requirements that govern them need to do likewise. Standardizing the entire ecosystem would allow developers and OEMs to regularly test their products against uniform benchmarks, ensuring they are secure while keeping costs down and launching quicker.

 

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Business

A LOW-CODE LONDON MARKET – THE KEY TO INDUSTRY FUTUREPROOFING

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By Richard Farrell, Chief Innovation Officer at Netcall

 

Aged 332 years, the London Market isn’t new to the need to modernise. For many years, the insurance market has been cautious regarding change and technological advancement, whilst facing mounting pressure to radically transform and keep pace in the digital world. The pandemic, however, has amplified this need for change. Following a year of economic instability, London Market firms risk becoming obsolete if they do not take immediate and urgent action to modernise.

In September 2020, the London Market reported a half-year loss of £400m, compared with a £2.3bn profit in the first half of 2019, and expects to pay out around £5bn in COVID-related claims. With further turbulence and financial uncertainty ahead, the corporate body must keep its sights firmly set on cutting unnecessary costs and transforming internal processes to facilitate this.

Whilst throwing the sector into chaos, the pandemic was a true eye-opener for the Market. Relying on systems and processes built years ago, which were centred around people doing business in a City office, left the London Market at a crossroads and facing once-in-a-lifetime challenges and opportunities. Lockdown created an urgent need for new systems to support a new hybrid workforce, and within this need now lies the opportunity for London Market firms to rejuvenate – building greater efficiency into systems and processes to enable agility and future growth, as well as long-term digital ways of meeting and working. Intelligent automation technologies such as low-code platforms, when combined with robotic process automation (RPA) and powered by artificial intelligence (AI), will be pivotal to this transformation. With these platforms, London Market business users can collaborate and build new applications with IT teams without the need for costly and time-consuming traditional coding methods.

As a result of redesigning processes, London Market businesses can identify where efficiencies can be made and then rapidly develop optimised systems that keep both technology and people at their core. This will be crucial to achieving significant long-term cost savings and maintaining the London Market’s current position on an international level.

 

Using 2020 challenges as inspiration to evolve

The last year has seen a range of hurdles for both the London Market and individual businesses: a shift to remote working, the need to optimise costs, and the imperative to maintain status in the global order. These have not been easy, and these challenges are likely only the start of greater change that we will see in the coming months and years.

Businesses have proven in the last 12 months that they can adapt and shift when needed with the Blueprint plan, Lloyd’s of London’s ambitious plan to create the world’s most advanced insurance marketplace. Blueprint Two, which was released in November 2020 and built on March’s Blueprint One, established new ways of doing business, underpinned by the need for digital channels that enable advanced data collection and management. The right tech and tools can enable brokers, insurers and partners with delegated authorities to operate at a materially lower cost, estimated to be at least £800m as part of this evolution.

As John Neal, Lloyd’s of London CEO, states, the London Market needs to make itself ‘more relevant, more innovative and much more cost-effective’. Solutions that enable rapid digital transformation, whilst boosting efficiency and lowering costs, will be crucial to achieving this goal.

 

Future-proofing the London Market 

Due to its ease-of-use, low-code platforms can empower London Market teams to collaborate to build new applications in the fastest way possible and speed through application backlogs. Rather than taking a rip-and-replace approach to innovation, the technology can enable London Market organisations to stitch legacy systems together with new applications – effectively building upon existing investments to provide a better user and customer experience.

With the right technologies, the London Market can rapidly reduce inefficiencies by automating manual or broken processes, whilst also integrating with a number of different systems. This will enable organisations to provide a central platform that can give visibility across all parties – and in turn enable better decision-making through richer data and the use of AI.

Perhaps one of the more pressing London Market processes brought into the limelight during the pandemic has been the process of claims management – which intelligent automation solutions can help with too. With so many stakeholders involved, managing the claims lifecycle can be extremely complex, and the sheer number of claims being processed means that teams face huge pressure to provide swift service, and to keep claims pipelines moving. By consolidating data and processes under one platform, the lifecycle management can be improved to provide real-time information relating to a company’s claims exposures, including aggregates, and other elements such as supplier management. Greater visibility of these elements will, in turn, drive greater sector efficiencies.

 

Reshaping the London Market once and for all 

The next few months will bring myriad challenges and opportunities around reshaping how London Market businesses work and trade for the benefit of its clients and people. There are considerations for all organisations, including new ways of employee and trading partner engagement. A one-size-fits-all strategy simply won’t work in such a complex environment, but using the right software can unlock business benefits and growth potential for London Market firms large and small.

Fundamentally, London Market firms must invest in and prioritise the technologies that will enable their workforce to save time and drive value back to the organisation – as well as work how they want to work. Whilst the social nature of the London Market, which is largely based on personal networks, indicates a strong return to office work when lockdown restrictions are lifted, there is still likely to be some level of remote working moving forward.

Flexible and agile intelligent automation technologies can empower the London Market to join data together across numerous back-end systems to provide an easy-to-use workflow across complex process requirements. By enabling employees to make better-informed underwriting and claims decisions, based on better access to enriched information, organisations can not only drive greater efficiencies, but keep up with the demands of a digital-first future.

 

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