How We Look at Risk

How We Look at Risk

Here’s a scenario: You want to hire a fisherman to catch fish. You arrive at a seaside village and visit two fishermen.

You first meet Fisherman A. His boat is brand new. When you speak to A, he appears passionate about fishing. He knows where and when to catch the best fish and how best to cook it. A proposes you invest $5,000 with him to buy new fishing equipment. In return, he will share 10% of his daily catch with you.

As you walk down the coast, you meet Fisherman B. He tells you that he has been fishing for 40 years and tells you stories about how he used to catch the best fish in his prime. He then proposes that you lend him $5,000 to repair his boat and buy new fishing equipment. In return, he guarantees to pay you back your principal in 3 years. He also guarantees that he will deliver 1 fish to you a day, rain or shine.

Who will you choose? A doesn’t promise you anything. The only assurance you have with A is that for as long as he is in business, you will get 10% of his daily catch. The safer approach seems to be B. You are guaranteed to get your money back after 3 years and during this time, you are assured of 1 fish a day.

As you would have probably guessed, in banking terms, A’s investment is a stock and B’s investment is a bond.

In a typical wealth management strategy, clients are often asked to fill in a risk profile. In these risk profiles, individuals are segmented into various buckets of risk appetites; portfolios are then constructed based on a percentage of asset classes.

For example, if your risk profile is low, you are advised to buy 80% bonds and 20% equities. If you are of a higher risk profile, you may buy 80% equities and 20% bonds.

But there’s no cookie cutter approach to this. The above example is not how we construct portfolios at Eu Capital. Our team does not view stocks as a riskier asset class and bonds as a less risky one. Risk is assessed based on the merits of each business.

Instead, we relentlessly look for the best business to buy in the world and will invest a larger percentage in our most confident businesses. If we cannot find any that is worth buying at the correct price, we will hold cash.

We are also not stock specialists that only invest in stocks. We will lend if the terms are right.

In addition to the percentage of asset class, we are also not limited by a mandate. In many mainstream mutual funds, not only are these funds constrained by a percentage of asset class (Eg. A balanced fund must hold 50% bonds and 50% equities), many are tied by unnecessary rules. (Another example of such a ‘rule’ is that at any single time, the fund is not allowed to hold more than 5% cash.)

If we feel that the macro environment is not right, we will exit the market and do it quickly. As independent asset managers, we are unconstrained in the global macro environment.