BUSINESS NEWS - The word risk always evokes an emotion. For some it is excitement at the anticipation of an opportunity or a thrill, while for others it is the fear and anxiety around losing something or possibly getting hurt. When it comes to investments, there is a plethora of terms relating to risk - from tracking error, standard deviation, volatility to drawdown risk.

A good way to look at investment risk is to view it as the probability of incurring a permanent capital loss over a particular time period. Using this framework, one would then put risk at the forefront of investment decisions.

There are a number of good reasons for putting risk first in an investment process. These include:

1. Protecting the base
This is the simple reality of needing to make up more than you lost to get back to where you were. For example, if you lost 20%, 35% or 50%, you need to return 25%, 50% and 100% respectively on the money you have left to be in the same position before the loss. So preventing losses is important. It’s not a symmetrical picture at all. So one needs to invest with a margin of safety – which means making sure the investment and associated risks are understood, well researched and that the price is cheap enough given the potential upside and downside.



4. Be fearful when others are greedy
Putting risk at the forefront of your investment process puts you in a better position to buy when others are fearful and sell when they are greedy. It is only when you have spent a lot of time considering all the risks that you can have the conviction to be contrarian when you need to.

5. Be a custodian
Putting risk first means that a manager should be a custodian of the investor’s investments and preferably manage their funds as if they were managing their own money. If they are co-investors in the funds they manage, they are much more likely to make the correct long-term decisions needed to generate safe returns. They are also likely to invest in companies that are managed by teams that generate good returns as they are themselves significant shareholders in their businesses. It becomes a partnership as opposed to an exercise in finding something you hope someone else will buy from you at a higher price!

Putting risk at the forefront of investment decisions enables a manager to make the correct long-term decisions in the best interests of their investors, and ultimately will provide both the peace of mind and returns investors need.