You can read about the most profitable stocks and the best funds in the newspapers or online each day. The majority of these are dependent on the returns (preferably short-term) since it is simple to quantify.
Then why do fund managers (myself including) speak of having low risk (especially when the return is less than an index that is benchmarked, using it as a justification)? Are risks important? And last but lastly, how do you measure it?
In the field of academic finance, the risk is usually determined by the degree to which a stock fluctuates (volatility or Standard deviation) and how it changes when compared to benchmarks (covariance).
A variety of key risk-related figures can be calculated using this method as a base. Most commonly used are Beta or Sharpe ratio. However, there are variations, including Sortino ratio, Treynor ratio Omega ratio Information ratio, Jensen’s Alpha and tracking error, and many more). The funds are classified into different risk categories (1-7) that are not very helpful information.
Former derivatives trader and author Nassim Taleb write about so-called ” alternative stories ” that are similar to the kind of thing Howard Marks in Oaktree calls ” things that could have happened. ” We don’t know what is likely to occur in the near future, but a lot of scenarios are likely to not occur.
” Outcome bias” is the term used to describe the merits of a decision by the results. If you leave the party and do not hurt anyone or are arrested, however, that doesn’t mean it was a smart choice to take.
There were several risks that did not appear to be a risk. In the banks, there are many risks that are often hidden. However, with Askim the Askim and Spydeberg Sparebank, it has recently come to light. A bank that has annual losses that are low doesn’t mean that the risk isn’t there or even invisible.
You may be aware of some of you from the hedge fund Archegos, which was into bankruptcy last year. Their shares in the businesses Discovery, as well as Viacom, were sold off forcibly; therefore, the prices of shares dropped by around 40%, was the chance of investing in these firms was the highest prior to or following being sold forcibly.
The financial theory that is based on stock changes would suggest that risk is greatest following the forced sale, which is illogical to me in my view.
MSCI has developed its own index that illustrates that the approach of low volatility in the last 15 years has yielded similar returns to the index for the world, however with fewer fluctuations.
However, I believe risk can be assessed even more accurately. I measure risk by the likelihood that the company I invest in could be a bad investment over the long term. If a stock falls by 75% has to go up 300% in order for it to be back at the same level.
The significance of avoiding this investment is very high. Therefore, proper risk management is a crucial element to achieving long-term outcomes.
Three Factors Could Cause Long-term Negative Investments:
- The company is faring worse and earning less than it did before
- The company is in debt more than it can manage and is required to undergo the process of refinancing using a powerful dilutive
- It is way too costly. I’m not too worried about this because, over the long term, valuation doesn’t provide much information. The most extreme instances of this are Cisco or Intel. Despite the positive development in key financial figures and other key figures, they haven’t given an increase in their returns since their respective peak around 20 years ago. However, they are not the only exceptions.
There are a variety of ways to look at point 1. One should not look to the point of saying, “This time is different ” This time is different ” is usually more likely to be wrong than right.
Also, if you purchase a company that has proven to be high-quality over a long period, chances are in your favor that it will continue to have excellent quality. But, at the same time, keep an eye on the company’s cyclical phase, i.e., profitability in relation to historical averages.
Equinor will make more money in 2021 than in 2020. This is likely in a larger part due to the higher price of gas and oil as opposed to the fact that they are the business with the highest growth rate and are an even better business in 2021 than the year prior.
The second point is easier to steer clear of. Companies that have no or little credit (relative to their earnings) are less risky. It’s not much more. It’s also not complicated for an inmate, although there are various valuation techniques.
For the investment fund FIRST Veritas which I manage, it’s, therefore, these risks I calculate and strive to reduce by calculating: Margin variance, cyclical phase, borrowing, and valuation. Thus, I’m not worried about the beta that firms have, but I don’t think it’s relevant.
In addition, there is a concept known as portfolio risk or diversification.
The amount of companies included in the portfolio isn’t as crucial; I would think that the overall portfolio has a broad exposure. It could include anything from raw materials, industries, and geographies, to end customers as well as political and social processes. If, for instance, the boat gets trapped on the Suez Canal, the Turkish Lira sinks in protests in Kazakhstan. The portfolio must be able to stand up to this. In no way in a portfolio setting do I care about the beta (or Sharpe ratio or.)
One thing is living within the ideal (as I view it) world. The other is living in the real world that we live in. Although I’m completely not concerned about the fluctuations in the stock market and fund prices by themselves, that doesn’t mean everybody else does.
Thus, I’ll need to be in a position to communicate this issue, as it’s not just the personal funds I manage. Apart from being informative and informative, it’s an opportunity to idea to write articles similar to this to provide the reasons behind my method of thinking.