Active Risk Management

What Is Investment Risk?

Keeping your money in a bank, instead of invested in the stock market, for example, is not risk free; it simply exposes your capital to a different basket of risks. For example, one significant risk of holding cash is losing the buying power of your cash due to the impact of inflation. Another real risk: your cash is subject to the credit risk of the bank. There are many examples, some recent, of banks that were thought to be strong that were suddenly declared insolvent by the regulators.

The Firm defines investment risk as the likelihood of the permanent loss of capital.

It is essential that clients understand that price fluctuation by itself, is not a useful measure of risk, because markets, and the pricing of securities, are driven not just by facts and fundamentals but by human emotions, which often dominate in the short run. In the long run (periods exceeding five years), fundamentals tend to win out.

This is why adhering to minimum investment horizons is critical to minimizing risk associated with the premature sale of investment assets.

An enormous benefit of correctly understanding what investment risk is, and is not, is the ability to weather price swings with relative calm, confidence and curiosity instead of panic and fear. Panic and fear (and greed) regularly lead investors to make extremely costly investing mistakes. If you see price fluctuation for what it is, then you will be able to see and take advantage of opportunities to buy when everyone else is panic selling and prices are making new lows.

Likewise, if fundamentals have cooled yet prices have reached new all-time highs, you will be able to appreciate the wisdom in selling, despite the tug of greed often seen at the top, when everyone is convinced that the security can only go up.

The key is remaining emotionally neutral, while recognizing the emotions at play and finding ways to use them to your advantage.

That said, we are the first to acknowledge that for most human beings, price fluctuation can be rattling and scary. Your job is to keep that in check.

How We Manage Risk

Our job is to manage actual risk as it is defined above. Based on historical drawdown statistics for stocks and bonds and related ETFs (downside fluctuation), you should not invest in the Firm's growth strategies (or anyone's for that matter) unless you can tolerate (tolerate does not mean you like it, nobody does) maximum drawdowns in the range of 35% to 50%. For context, historical drawdowns in the S&P 500 and Nasdaq 100 have been as large as 50-80%.

While we aim to keep our drawdowns below that of the historical range of the larger U.S. indices, there is no guarantee that we can do so.

There are a variety of ways we may choose to regulate risk:

1. The selection, sizing and liquidity characteristics of individual positions
2. The selection of strategies used in client portfolios
3. The use of strategies whose time horizon matches liquidity needs
4. Subsequent deletion(s) and addition(s) of individual positions
5. The purchase of portfolio insurance (put options for example)

How Much Will Each Strategy Make?

A question that is frequently asked is "How much will each Strategy make?"

Each strategy is designed to target a certain level of return. However, since the future will look different than the past, we cannot say. Any such prediction would be reckless and misleading, because each economic season brings different combinations of risk and return. What we can provide you is historical back-tested data on most strategies that illustrates how each would have performed over the last 25 years or so, as well as rolling period best/worst return analysis as well as downside risk statistics like the maximum drawdown over a given period of time as well as its Ulcer Index measurement.

The key is to have a team that is watching your back and proactively managing risk.