Wednesday, 18 April 2012

RISKS: Not Dead Yet: Surviving Today to Triumph Tomorrow

Portfolio philosophy
Long term investing
Concentrated portfolio
Undervalued micro-cap growth companies
10-15% stake in each company
Active constructive engagement
Friendly long-term 7-9 years average ownership
Aim to build shareholder value

Return of my capital is more important than return on my capital.  Live to see another day.  Risk is real.
Risk has to be managed - at portfolio level and at company level.
Risk is not Beta or price fluctuation (volatility). To say these are risks is nonsense.
The sharp falls of 2007 to 2009, puts the academic theories of market efficiency and its utility in question.
What is taught in business school is questionable.
For example, the Madoff fund provided steady 10%-15% annual return with little volatility.
By definition, Madoff's fund had low Beta and was not risky but it is virtually a total permanent loss today except for some clawback in value from litigation.
Risk is not rotational short term loss given a long term investment orientation.
If is is not permanent, it can come back, and often it can come back very quickly.
To a trader, these rotational short term losses are often permanent and market losses are real.
Market fluctuations bring pain and fear and are viewed as opportunities, to sell or to back up the truck when Mr. Market is upset.
What are the real risks facing the investment managers?  What are the risks in investing in a single company?

Risks facing the investment manager.

Leverage risk
Leverage is lethal.
LTCM was leveraged 50 - 100:1
Bear Stern and house of cards were leveraged 50:1
Leyman was also in the comparable area.
What does leverage of 50:1 mean?
If the asset is worth 100 sen, your equity is 2 sen.
A 2% downward fluctuation will wipe out all your equity.
The stock market has seen more 2% fluctuations in the 7 months of 2011 than in the last 13 years.
Leverage magnifies the risk of loss.
We don't use leverage to magnify our return.
The only time for using leverage is as a temporary bridging source of liquidity when we found something we wish to buy, until our liquidity of fund is available.

Redemption risk.
Investors of fund tend to cash out at the worst possible time.
Selling the stocks in a fund to pay investors at this time is not the best practice.
Therefore, all new investors are educated and their funds are locked in for at least 5 years.

Other risks:
Counter party risk.
Custodian risk.
Regulatory risk.
Execution risk
Fraudulent earnings risk.

Risks facing the individual investment

Debt risk
Net cash position.  Debt, if used, should be modest in relation to trough EBITDA.  Preferably long term debt used to fund business.

Legal and regulatory risk
High level of these risks should make you stay away.

Market development risk
Not interested in start ups.

Competition risk
Invest in the leader in the industry with a big moat.

Execution risk
Embrace management team that can execute their strategy.

Valuation risk
We like to back up the truck to scoop when the value is good.

Exit strategy risk
Multiple pathway can be worked with the management team to make for more liquidity.

Fraudulent risk.
Check out carefully.  Due diligence.

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