Risk Management

Many more things can happen than will happen in financial markets. Our job is to protect your capital under all circumstances. We must survive the worst of times. This is why we invest with no leverage and remain liquid at all times. Valuation and business quality are cornerstones of our process. These attributes protect the downside.

Avoiding high risk is a critical element of our investment process. Greater risk does NOT guarantee greater return. Our objective is to compound long-term returns at a reasonable rate while limiting the risk of a permanent loss of capital. The main risk we take is in the stocks we own. We mitigate that risk by:

  • Buying only businesses which we understand, and where we have high conviction that the future value is considerably above current price. High conviction is essential. It allows us to increase position when a stock declines in value, and to stay in the position during periods of adverse economic conditions.
  • Buying only businesses where we are comfortable that (1) revenue growth in dollar terms is sustainable (preferably though volume growth, as opposed to price/mix); (2) operating margins are sustainable; (3) cash generation is strong; and (4) cash is either deployed internally at high incremental returns or is returned back to shareholders. We pass on many businesses that don’t meet these criteria.
  • We don’t call direction of markets or bet on interest rates or any other macro variable.
  • Buying business with negligible left tail risks. Left tail is defined as a low probability event which can cause a material damage to the business. Examples for left tail risks include adverse regulation, substitute products, better products launched by competitors or bad capital allocation.
  • Diversifying adequately – our diversification efforts are driven mainly by reviewing the correlation of the profit streams of our portfolio companies. We look to add to our portfolio businesses where the drivers of their profits have limited correlation with the existing portfolio.  
  • Liquidity – we invest mainly in mid to large capitalization stocks with ample liquidity allowing us to exit quickly if we elect to. Liquidity provides us with the ability to cut our losses when we are wrong, or when events we did not anticipate take place.
  • No leverage. Our gross exposure is less than 100% and we typically don’t invest in highly levered businesses.  The exception is investments in well run financial companies.

In summary, we believe that the risk of significant permanent loss of capital in our fund is low. You lose a lot of money when you speculate, employ a lot of leverage, enter into illiquid positions or ‘bet the farm’ on few stocks. We don’t do any of that.