Managing Risk

As fiduciaries, we are obsessed with minimizing and controlling risk. Our philosophy for portfolio risk management is based on Warren Buffett's timeless advice:

  • Rule Number 1: Don't lose money
  • Rule Number 2: Don't forget Rule Number 1

Our goal is to avoid the permanent loss of capital and to compound capital at high rates of return over time.

Volatility is Not Risk

We approach the markets with the philosophy that short term stock price volatility in the absence of any meaningful fundamental changes in a company does not equal risk. Price volatility can become risk for investors under certain circumstances. We manage price volatility risk by adhering to three principles:

  1. Avoid investing in companies that need to raise external debt or equity capital and those that carry high levels of debt.
  2. Not carrying any leverage in the portfolio and not using any kind of derivatives. We run a long only portfolio and do not short either directly or synthetically.
  3. Selecting our investors carefully.

Fundamental Stop Loss

Since we do not take price volatility as a risk signal, we do not impose price-based stop losses on our portfolio. Instead, we use what we like to call our fundamentals stop loss.

Before we invest in any stock, we conduct detailed and lengthy due diligence. We then build an investment thesis based on our view and expectations of the fundamentals of the company. We are very conservative in our appraisal of any company’s prospects. We don’t factor in unknown outcomes in our investment theses and consider them to be free options.

Once we invest in a company, we track its underlying fundamentals on a continual basis. We continually compare the unfolding fundamental reality to our investment thesis, which is also periodically updated. Whenever we observe a major adverse deviation between the emerging fundamental reality of a company and our investment thesis, a fundamental stop loss is triggered. At that point we immediately initiate an exit from the position irrespective of whether our investment is in the money or out of the money.

Conversely, if the underlying reality is in line or better than our investment thesis and the stock experiences exaggerated price corrections, we use the volatility as a buying opportunity.