Not All Risks Are Created Equal
by Pauline Shum Nolan, PhD, and Simiao Zhou, PhD and Alex Mustata, M.A.
If you ask investment advisors to quantify risk, they are most likely going to refer you to a well-known statistical concept called standard deviation (SD). Standard deviation in this context measures the dispersion of an investment’s returns over time, also known as total risk in finance.
However, two portfolios with the same standard deviation (and other overall risk characteristics) may have very different risk drivers. Consider the two portfolios in Figure 1 below. They have the same standard deviation of 10.50%. However, you can see from the charts that their risk exposure to various industrial sectors is very different.
Figure 1: Sector Risk Exposure
April 2007 - July 2026
Portfolio 1 [1]
Annualized SD (Total Risk): 10.50%
Annualized return: 10.32%
Portfolio 2 [2]
Annualized SD (Total Risk): 10.50%
Annualized return: 10.07%
Over the sample period, there is only a 25-basis-points difference in annualized return between the two portfolios. Yet, depending on your sector outlook going forward, you may have a preference for one portfolio over the other: Portfolio 1 has substantially more exposure to Financials, while Portfolio 2 has much more Information Technology (IT) and Materials risks. Another consideration may be more personal. For example, if you work in the IT sector - meaning that your human capital is significantly correlated with the fortunes of that sector - you may want your financial capital to be less concentrated in IT risk. In this case, you would prefer Portfolio 1.
The same considerations apply if you look at the macroeconomic risk exposures of the two portfolios in Figure 2. Portfolio 1 has a bigger exposure to the U.S. dollar and credit risk. Portfolio 2, meanwhile, has a much larger exposure to interest rates, and a smaller exposure to the U.S. dollar.
Figure 2: Macroeconomic Risk Exposure
April 2007 - July 2026
Portfolio 1 [1]
Portfolio 2 [2]
Interestingly, both portfolios hold identical 10% positions in the GSCI Commodity Index fund (ticker: GSG) and the Gold Bullion fund (ticker: CGL), yet only Portfolio 1 shows separate inflation and gold risk exposure, while oil exposure is fairly similar in the two portfolios. This illustrates that a holding's contribution to portfolio risk depends not only on the holding itself, but also on how it interacts with the rest of the portfolio through diversification effects. Portfolio-specific risk is the largest category in both portfolios, representing the portion of estimated risk that is not attributed to the named macroeconomic factors in this analysis. So again, depending on your macroeconomic outlook and personal circumstances, you will likely have a preference for one portfolio over the other.
If you are looking for a low-cost, geographically diversified portfolio, there are inexpensive options from different providers, including the popular fund of funds (asset allocation) solutions. Bear in mind that they are one-size-fits-all solutions, and if you have specific risk preferences such as those discussed above, you will need a more tailored portfolio, but it does not have to be expensive either. The Portfolio Builders in Wealthscope can help you find the right one.
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[1] Portfolio 1 is made up of the following 7 ETFs: iShares MSCI Global Min Vol Factor ETF (Ticker: ACWV) 10%, iShares S&P/TSX Canadian Dividend Aristocrats Index ETF (Ticker: CDZ) 20%, Invesco QQQ Trust (Ticker: QQQ) 10%, Vanguard Morningstar Small-Cap ETF (Ticker: VB) 20%, iShares S&P/TSX Capped Financials Index ETF (Ticker: XFN) 20%, iShares Gold Bullion ETF (Ticker: CGL) 10%, and iShares S&P GSCI Commodity-Indexed Trust (Ticker: GSG) 10%.
[2] Portfolio 2 is made up of the following 7 ETFs: iShares MSCI Global Min Vol Factor ETF (Ticker: ACWV) 17.28%, iShares MSCI Emerging Markets Index ETF (Ticker: XEM) 20%, Invesco QQQ Trust (Ticker: QQQ) 10%, Vanguard Morningstar Small-Cap ETF (Ticker: VB) 20%, iShares S&P/TSX Capped Information Technology Index ETF (Ticker: XIT) 12.72%, iShares Gold Bullion ETF (Ticker: CGL) 10%, and iShares S&P GSCI Commodity-Indexed Trust (Ticker: GSG) 10%.