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Put stocks into risk-level buckets

In this lesson we learn about how to use risk tolerance to create five risk buckets from conservative to aggressive (low to high risk). Ranking stocks by volatility, the entire market is divided into five risk buckets. We explain their features and show you how to create the basis of a portfolio for each risk bucket and populate them with stocks.

What are risk buckets?

The iron law of investment is that to earn higher returns an investor must take more risk. The level of risk an investor is willing to bear in the expectation of a given return is known as risk tolerance.

Depending upon on where one is positioned on this risk spectrum, an investor will seek out share holdings that meet the targeted investment objective and risk-return profile.

How volatility can be a partial proxy for risk

Volatility is a key proxy for risk. The more volatile a share price, the higher the risk to shareholder returns, although investment horizon (how long the stock will be held in the portfolio) is a factor here; long-term investors will be less concerned by bouts of short-term volatility..

To create our risk buckets we used as a baseline the Stockopedia Risk Rating.

The division of the rankings into the five risk groupings are not dependent on Stockopedia.

The risk rating ranks stocks by 3-year normalised (standard deviation of daily returns time series) volatility but the risk bucket screener ranks for 1-year volatility.

But volatility by itself can’t be relied upon because it really is only telling the investor what the market thinks about how risky a stock is- that is different from a measure of how risky a stock actually is.

More importantly perhaps, a volatility-centric view is at odds with the fact that increasing volatility (higher risk) leads to smaller risk adjusted returns (measured by the Sharpe ratio).

Why investors don’t rely on volatility alone: quality value growth and momentum

This divergence from our so-called iron risk-return law is explained by a tendency by the investors for a bias towards overpricing speculative or high growth potential stocks. This happens for a variety of reasons, including investment firms and brokers’ systemic bias towards placing riskier buying opportunities in front of their clients, with bonus systems that remunerate that behaviour. Investors are also less inclined to leverage positions in lower volatility shares and investors are generally willing to pay more now because they hope for a later windfall.

With this in mind, the risk groupings below need to be viewed in conjunction with QualityValueGrowth and Momentum.

Stockopedia’s StockRank is helpful here as it is an equally weighted combination of the ValueRank, QualityRank and the Momentum Rank. These three basic ranks are computed for every company in the market on a daily basis, summed and then re-ranked as a percentile from 0 (worst) to 100 (best).

The StockRank, says Stockopedia, is based upon the three of the strongest ‘anomalies’ in finance:

  • Quality (risky stocks don’t pay),
  • Value (cheap stocks beat expensive stocks) and
  • Momentum (winners beat losers).

Below we show how those groupings map to our slightly different labelling:

  • conservative (lowest volatility 10% of the market) – > conservative
  • balanced (next lowest 15% of the market) – > moderately conservative
  • adventurous (next lowest 20% of the market) – > moderate
  • speculative (lowest volatility 25% of the market) – > moderately aggressive
  • highly speculative (lowest volatility 30% of the market) – > aggressive

The five classifications (from least to most volatile) are Conservative, moderately conservative, moderate, moderately aggressive and aggressive.

The top decile comprises the most conservative 10%, the next 15% is moderately conservative, 20% moderate, 25% moderately aggressive and 30% aggressive. Stockopedia uses proprietary measures of volatility, which account for the fact that some stocks have shorter histories and/or are traded less frequently than others.

Conservative

The conservative investor emphasises capital preservation over high returns that might risk the principal. Comfortable to accept low returns for higher liquidity and flexibility. Targets income (for reinvestment and/or consumption needs) and some capital growth.Fall less in negative markets, but rise more slowly in bullish markets. These stocks will tend to over-perform over the long term.

Moderately conservative

Moderately conservative investors emphasise capital preservation but willing to take on a small modicum of risk and accept some volatility for an element of capital growth. The investor is comfortable accepting a small degree of risk and volatility to seek some degree of appreciation. Requires greater liquidity and will accept lower returns for minimal risk. Targets a mixture of income yield and capital growth. Outperform during ‘risk on’ rising markets, but fall faster and harder in ‘risk-off’ downturn periods.

Moderate

Moderate investor seeks to reduce risk while enhancing returns. Will accept modest risks for higher long-term returns. A Moderate investor will accept short-term loss of principal and lower liquidity in exchange for long-term capital appreciation. Requires reasonable, relatively stable income and capital growth.

Moderately aggressive

A moderately aggressive investor seeks higher long-term returns and will accept considerable risk in that quest. Will endure short-term losses of principal and volatility for long-term capital appreciation. Liquidity is not a primary concern. Targets income and capital growth. Income reinvested.

Aggressive

Aggressive investors are willing to take high risk to maximise long-term investment returns. Puts a priority on maximising long-term returns over capital preservation. Liquidity is not a consideration. Aggressive investors are willing to contend with high levels of volatility and losses of principal. Targets capital growth. Income reinvested.

Conservative stocks

Companies that have demonstrated steady growth in revenue and profit over a long period of time. They are reliable businesses that have well-established business models and are considered to be lower-risk investments. Large caps predominate.

Risk rating:

conservative

Screener:

bottom 10% of market ranked by volatility

Market value grater than £10 million

Excludes financials

 

buyshares conservative portfolio rules

BuyShares Conservative Portfolio screen example

buyshares conservative portfolio constituents

Ticker Name Mkt Cap £ (millions) 1 Year Volatility %
SMJ J Smart & Co (contractors) 47.70 11.06
JEL Jersey Electricity 151.97 11.47
ZEG Zegona Communications 243.06 23.68
ULVR Unilever 126473.75 23.94
CRDA Croda International 8210.21 24.36
GSK GlaxoSmithkline 69049.12 24.95
ECEL Eurocell 196.28 25.50
CCP Celtic 706.49 25.57
DGE Diageo 61437.46 25.87
MRW Wm Morrison Supermarkets 4133.81 26.30

 

BuyShares Conservative Portfolio – Quality, momentum, value, growth scores:

conservative portfolio stockrank

Moderately conservative stocks

Shares of those companies that exhibit below-market volatility, and have firm long-term consistent earnings. A mix of large cap companies with established positions in their markets and, have quality balance sheets and strong management.

Risk rating:

balanced

Screener:

next 15% of the market ranked by 1-year volatility

market cap greater than £10 million

exclude financials

buyshares-moderate-conservative

BuyShares Moderately Conservative Portfolio screen example

buyshae moderately conservative portfolio members

BuyShares Moderately Conservative Portfolio – top 50 of 106 members

Ticker Name Mkt Cap £ (millions) Risk Rating 1 Year Volatility %
TSCO Tesco 20987.46313 Balanced 27.04
REL Relx 33046.05627 Balanced 27.18
HLMA Halma 9377.389841 Balanced 27.37
CFX Colefax 36.992004 Balanced 27.92
AZN Astrazeneca 107831.3851 Balanced 28.27
RB. Reckitt Benckiser 52320.75796 Balanced 28.32
SPX Spirax-sarco Engineering 8516.610564 Balanced 28.46
TATE Tate & Lyle 3025.998781 Balanced 28.53
NG. National Grid 33238.82665 Balanced 28.56
CAM Camellia 187.1255 Balanced 29.39
SVT Severn Trent 5999.301408 Balanced 29.74
JLG John Laing 1446.210865 Balanced 29.90
BVIC Britvic 1989.859242 Balanced 30.09
OCN Ocean Wilsons Holdings 226.323456 Balanced 30.16
IPEL Impellam 106.5341007 Balanced 30.21
ACC Access Intelligence 57.38297996 Balanced 30.45
BA. Bae Systems 15552.47851 Balanced 30.51
SGE Sage 7777.397929 Balanced 30.66
AXS Accsys Technologies 141.769199 Balanced 30.75
ITRK Intertek 9922.449448 Balanced 30.84
RTO Rentokil Initial 9971.603347 Balanced 31.10
RMV Rightmove 5807.875342 Balanced 31.12
BNZL Bunzl 8616.116985 Balanced 31.30
QQ. Qinetiq 1487.325943 Balanced 31.38
SYS Sysgroup 16.3084977 Balanced 31.83
PNN Pennon 4334.401006 Balanced 31.89
UU. United Utilities 6057.9996 Balanced 31.96
CTH Caretech Holdings 517.2051434 Balanced 32.22
EXPN Experian 28286.44038 Balanced 32.29
ADES Ades International Holding 284.6649113 Balanced 32.31
SN. Smith & Nephew 13183.58621 Balanced 32.33
BME B&m European Value Retail Sa 5099.736117 Balanced 32.55
MRL Marlowe 300.9915558 Balanced 32.60
DCC Dcc 5268.493263 Balanced 32.85
SAG Science 104.41853 Balanced 32.91
LSC London Security 283.2401187 Balanced 32.93
IMB Imperial Brands 12445.26653 Balanced 33.00
CWK Cranswick 1786.471826 Balanced 33.07
CGS Castings 139.6226176 Balanced 33.18
PZC Pz Cussons 1095.392273 Balanced 33.26
OOUT Ocean Outdoor 256.7887594 Balanced 33.28
TFW Fw Thorpe 343.7910412 Balanced 33.29
JHD James Halstead 1143.336554 Balanced 33.38
MBH Michelmersh Brick Holdings 86.36566976 Balanced 33.38
SBRY J Sainsbury 4527.901792 Balanced 33.74
MMH Marshall Motor Holdings 99.74610218 Balanced 33.86
DWHT Dewhurst 77.1773509 Balanced 34.03
HFG Hilton Food 958.4696628 Balanced 34.03
LTHM James Latham 176.12208 Balanced 34.10
SSE Sse 13999.49439 Balanced 34.24

BuyShares Moderately Conservative Portfolio – Quality, momentum, value, growth scores:

moderately conservative stockrank

Moderate stocks

Will hold a blend of large and a minority of mid cap stocks.Seeks out cash-generative companies and steady earnings in expanding markets. Prefers the shares of companies with predictable and stable sales, revenue and earnings.

Risk rating:

adventurous

screener:

next 20% of market ranked by 1-year volatility

market value greater than £10 million

exclude financials

buyshares moderate portfolio rules

BuyShares Moderate Portfolio members

moderate portfolio stockrank

BuyShares Moderate Portfolio – top 50 of 230 members

Ticker Name Mkt Cap £ (millions) Risk Rating 1 Year Volatility %
NMRP National Milk Records 21.98 Adventurous 24.87
CDGP Chapel Down 113.01 Adventurous 35.51
SFR Severfield 166.43 Adventurous 38.26
VTC Vitec 339.89 Adventurous 38.36
DPLM Diploma 2835.07 Adventurous 38.37
GLTR Globaltrans Investment 790.37 Adventurous 38.58
BHP Bhp 82764.08 Adventurous 38.68
SCT Softcat 2449.77 Adventurous 38.80
UDG Udg Healthcare 1836.69 Adventurous 39.20
KETL Strix 451.45 Adventurous 39.30
FSTA Fuller Smith & Turner 783.90 Adventurous 39.33
SYNT Synthomer 1659.47 Adventurous 39.34
ANCR Animalcare 111.11 Adventurous 39.35
WYN Wynnstay 64.02 Adventurous 39.36
GAMA Gamma Communications 1663.97 Adventurous 39.36
AFM Alpha Financial Markets Consulting 212.79 Adventurous 39.39
DVO Devro 266.45 Adventurous 39.41
SMIN Smiths 5544.47 Adventurous 39.44
ROR Rotork 2682.87 Adventurous 39.54
ABC Abcam 2843.37 Adventurous 39.55
OMG Oxford Metrics 100.59 Adventurous 39.65
HAS Hays 1887.81 Adventurous 39.70
EPWN Epwin 93.63 Adventurous 39.71
AEP Anglo-eastern Plantations 196.99 Adventurous 39.80
GTLY Gateley Holdings 148.78 Adventurous 39.88
AVON Avon Rubber 1287.47 Adventurous 39.94
NICL Nichols 408.90 Adventurous 40.10
YNGA Young & Co’s Brewery 472.36 Adventurous 40.16
BAG A.g.barr 524.86 Adventurous 40.16
ECK Eckoh 166.24 Adventurous 40.23
FIH Fih 26.88 Adventurous 40.25
ERM Euromoney Institutional Investor 928.96 Adventurous 40.34
SMDS Ds Smith 4299.45 Adventurous 40.39
BILN Billington Holdings 37.51 Adventurous 40.41
AVG Avingtrans 92.20 Adventurous 40.42
IQG Iqgeo 34.22 Adventurous 40.63
SIS Science In Sport 44.58 Adventurous 40.69
AMS Advanced Medical Solutions 482.22 Adventurous 40.70
PAGE Pagegroup 1280.30 Adventurous 40.96
INF Informa 6110.70 Adventurous 40.96
AVV Aveva 7291.11 Adventurous 41.05
KBT K3 Business Technology 39.08 Adventurous 41.12
QRT Quarto Inc 21.47 Adventurous 41.29
CCR C&c 552.06 Adventurous 41.31
RNWH Renew Holdings 380.99 Adventurous 41.34
SEY Sterling Energy 26.63 Adventurous 41.48
BOOT Henry Boot 326.29 Adventurous 41.57
COA Coats 828.70 Adventurous 41.68
BP. Bp 42438.32 Adventurous 41.71
RCN Redcentric 203.77 Adventurous 41.80

BuyShares Moderate Portfolio – Quality, momentum, value, growth scores:

moderate stockrank

Moderately aggressive stocks

Invests in large, mid-cap and small-cap stocks, with an objective of moderately above average long-term returns. Mid-cap tech and pharma stocks for capital appreciation with an element of safety from consumer non-cyclicals..

Risk rating:

speculative

Screener:

next lowest 25% of market ranked by 1-year volatility

market value greater than £10 million

excludes financials

moderately ggressive portfolio

BuyShares Moderately Aggressive Portfolio screen example

moderately aggressive portfolio members

BuyShares Moderately Aggressive Portfolio screen Top 50 of 319 constituents

Ticker Name Mkt Cap m GBP Risk Rating 1 Year Volatility %
MJH Mj Hudson 71.95 Speculative 49.03
KOO Kooth 80.16 Speculative 52.09
SDL Sdl 675.94 Speculative 52.15
PRTC Puretech Health 714.36 Speculative 52.16
GHH Gooch & Housego 251.57 Speculative 52.18
RM. Rm 142.68 Speculative 52.22
OKEY O’key Sa 177.12 Speculative 52.26
PFD Premier Foods 801.24 Speculative 52.26
FOUR 4imprint 567.33 Speculative 52.31
MGP Medica 122.41 Speculative 52.34
TSTL Tristel 231.45 Speculative 52.35
RBGP Rbg Holdings 55.63 Speculative 52.52
AVAP Avation 72.70 Speculative 52.64
FRES Fresnillo 9900.17 Speculative 52.76
ULS Uls Technology 34.06 Speculative 52.78
TCM Telit Communications 176.93 Speculative 52.81
CHH Churchill China 114.09 Speculative 52.87
PTEC Playtech 1102.13 Speculative 53.05
888 888 Holdings 982.68 Speculative 53.07
SUR Sureserve 80.48 Speculative 53.30
KLR Keller 431.09 Speculative 53.31
PETS Pets At Home 2039.00 Speculative 53.34
RBN Robinson 21.43 Speculative 53.37
SPR Springfield Properties 92.01 Speculative 53.44
THW Daniel Thwaites 50.00 Speculative 53.47
NFC Next Fifteen Communications 444.33 Speculative 53.59
HVT Heavitree Brewery 22.69 Speculative 53.70
CAPD Capital 88.35 Speculative 53.76
JDW J D Wetherspoon 931.14 Speculative 53.78
RDT Rosslyn Data Technologies 19.71 Speculative 53.79
MMX Minds Machines 44.20 Speculative 53.83
TM17 Team17 940.03 Speculative 53.89
SYS1 System1 13.86 Speculative 53.92
GHT Gresham Technologies 78.72 Speculative 53.96
MWE Mti Wireless Edge 41.79 Speculative 53.96
BRCK Brickability 100.25 Speculative 54.14
FLTR Flutter Entertainment 20554.95 Speculative 54.23
IGR Ig Design 400.76 Speculative 54.46
INS Instem 93.19 Speculative 54.62
DWF Dwf 230.43 Speculative 54.65
FIPP Frontier Ip 36.58 Speculative 54.82
VANL Van Elle Holdings 39.47 Speculative 54.91
WTG Watchstone 27.62 Speculative 54.94
TIDE Crimson Tide 17.38 Speculative 55.03
TIFS Ti Fluid Systems 988.72 Speculative 55.04
GFTU Grafton 1626.29 Speculative 55.05
GYS Gamesys 1409.45 Speculative 55.07
MGGT Meggitt 2287.43 Speculative 55.10
RWA Robert Walters 321.01 Speculative 55.13
AMYT Amryt Pharma Holdings 317.46 Speculative 55.13

Aggressive stocks

Will include many growth stocks, many at the small-cap end of the spectrum. Higher proportion of higher risk speculative holdings. Focus on companies in fast-growing markets. These stocks have a tendecy to outperform in bull markets and underperform under bearish market conditions.

Risk rating:

highly speculative

Screener:

next lowest 30% of market ranked by 1-year volatility

market value greater than £10 million

excludes financials

buyshares aggressive portfolio

BuyShares Aggressive Portfolio screen example

aggressive portfolio members

BuyShares Aggressive Portfolio top 50 of 205 constituents

Ticker Name Mkt Cap m GBP Risk Rating 1 Year Volatility %
PRM Proteome Sciences 11.51 Highly Speculative 86.88
EME Empyrean Energy 19.33 Highly Speculative 87.09
RBD Reabold Resources 45.07 Highly Speculative 87.59
CNS Corero Network Security 48.25 Highly Speculative 88.12
EMH European Metals Holdings 36.36 Highly Speculative 88.16
ACSO Accesso Technology 119.52 Highly Speculative 88.55
PXS Provexis 11.91 Highly Speculative 88.84
BMN Bushveld Minerals 129.71 Highly Speculative 89.06
FRAS Frasers 1842.63 Highly Speculative 89.10
IOF Iofina 25.42 Highly Speculative 89.15
TRN Trainline 1592.98 Highly Speculative 89.35
HZM Horizonte Minerals 101.46 Highly Speculative 89.35
SLN Silence Therapeutics 324.05 Highly Speculative 89.60
CORA Cora Gold 19.00 Highly Speculative 89.65
GDP Goldplat 12.39 Highly Speculative 90.17
IGP Intercede 39.12 Highly Speculative 90.27
LOOP Loopup 133.06 Highly Speculative 90.29
AIR Air Partner 38.68 Highly Speculative 90.34
RKH Rockhopper Exploration 27.33 Highly Speculative 90.48
ACP Armadale Capital 18.38 Highly Speculative 90.72
TRMR Tremor International 265.81 Highly Speculative 90.95
ZOO Zoo Digital 39.89 Highly Speculative 91.12
UJO Union Jack Oil 31.71 Highly Speculative 91.17
FAR Ferro-alloy Resources 28.93 Highly Speculative 91.26
BARK Barkby 33.82 Highly Speculative 91.83
WBI Woodbois 35.77 Highly Speculative 91.90
CKT Checkit 27.29 Highly Speculative 92.03
ACT Actual Experience 47.65 Highly Speculative 92.07
ITM Itm Power 1310.63 Highly Speculative 92.12
IQE Iqe 439.14 Highly Speculative 92.19
ARE Arena Events 12.63 Highly Speculative 92.23
LUCE Luceco 350.54 Highly Speculative 92.24
EQLS Equals 44.83 Highly Speculative 92.29
COST Costain 104.34 Highly Speculative 92.70
NCCL Ncondezi Energy 12.94 Highly Speculative 92.71
BYOT Byotrol 32.66 Highly Speculative 92.76
TED Ted Baker 193.10 Highly Speculative 92.96
AGM Applied Graphene Materials 17.62 Highly Speculative 92.98
FTC Filtronic 17.33 Highly Speculative 93.05
BILB Bilby 12.33 Highly Speculative 93.30
CPI Capita 431.43 Highly Speculative 93.31
CPX Cap Xx 24.32 Highly Speculative 93.33
LGRS Loungers 150.02 Highly Speculative 93.37
IKA Ilika 123.35 Highly Speculative 93.49
CLSN Calisen 909.65 Highly Speculative 93.51
BOOM Audioboom 24.95 Highly Speculative 93.51
AAF Airtel Africa 2461.59 Highly Speculative 93.64
SMRT Smartspace Software 26.14 Highly Speculative 93.93
SDRY Superdry 124.19 Highly Speculative 93.95
SBTX Skinbiotherapeutics 21.81 Highly Speculative 94.42

 

BuyShares Aggressive Portfolio – Quality, momentum, value, growth scores:

aggressive portfolio stock rank

How to use the risk-level buckets

An investor can either confine themselves to one bucket for their stock investments or introduce an element of diversification by holding in set proportions across the risk spectrum. For example a more cautious investor might invest 25% in conservative stocks, 25% in moderately conservative, 25% in moderate and 25% in moderately  aggressive.

What is of rebalancing and why is it important?

A portfolio has to be rebalanced as the valuation of the stocks held changes and the proportions in the overall portfolio move away from the risk bucket proportion allocated.

Where are stocks in the asset allocation pyramid?

A fully diversified investment portfolio should should not be confined to stocks from the risk buckets outlined above – other asset classes should be used to dampen volatility and risk. By spreading investments across a number of asset classes that have low return correlations to each other, stock investors further diversify to control risk.

Top of pyramid (high risk)

Penny stocks, alternative investments (including collectibles, crypto), leveraged derivatives

Mid-section of pyramid (medium risk)

Equities, equity mutual funds (plus investment trusts and ETFs that have an appropriate risk-return profile), property, high-yield bonds, debt

Base of pyramid (low risk)

Cash, bonds, commercial notes, debt