There is no doubt that risk management is an important part of long term investment returns. One only has to be familiar with the law of numbers to realize that the percentage return to recoup a loss is in excess of the loss itself (i.e., a 50% loss requires a 100% gain to fully recover). As money managers at Pinnacle, we wear dual and sometimes conflicting hats. On one hand we want to maximize long term wealth for our investors, while on the other hand we need to manage risks to that wealth.
Today you don’t have to look far to find significant pockets of risk. There are risks to the economic recovery, risks in the amount of debt in the system, risks regarding regulation, higher unemployment, trade wars, etc. I can say with high conviction that the current macro backdrop leaves the potential for very risky “fat tail” (low probability) events unusually high. With that landscape in mind, it should put us at ease that we are being conservative in light of those risks.
That being said, we don’t feel such comfort on a day like today, when risk markets are exploding higher on the perception that central banks around the world appear to be opening up the liquidity spigots to try and reflate the system further. On days like this we must confront the wealth maximizing hat, and wonder whether our management of the risks is warranted in light of today’s business cycle, technical, and valuation profile.
So for today we are left feeling like a salmon swimming upstream, as we have forfeited potential gains as a trade off for increased safety. But tomorrow is Wednesday, and the team will be discussing what has changed in the three core tenets of our process (business cycle, technical conditions, and valuation). No doubt, we’ll be challenging our own assumptions to make sure we believe we are striking the right balance between risk management and wealth maximization at this time.
