MITIGATING DOWNSIDE RISK THROUGH VALUE INVESTING
Any type of investment will always be
associated with inherent risks one way or another due to uncertainty. Investors
who prefer low downside risk may seriously consider value investing as one of
the approach to achieve their investment goals. This is mainly because this
approach is not only very prudent in practice but it also will reward its
followers handsomely, provided they are strictly guided by its sound principles
and its best practices.
To have a clear framework on how it
works, we need to fully understand what is meant by downside risk and how it
works to preserve its investment value.
DEFINITION OF 'DOWNSIDE RISK'
“Downside Risk” is an estimation of a security's potential to suffer a
decline in value if the market conditions change, or the amount of loss that
could be sustained as a result of the decline. Downside risk explains a
"worst case" scenario for an investment, or how much the investor
stands to lose. Some investments have a finite amount of downside risk, while
others have infinite risk. The purchase of a stock, for example, has a finite
amount of downside risk; the investor can lose his or her entire investment.
The sale of a stock, however, as accomplished through a short sale (or "selling
short") entails unlimited downside risk, since the price of the security
could continue rising indefinitely.
CONSERVATIVE YET HOLISTIC APPROACH
Value investing, by its nature, has taken all measures in establishing
all possible downside risks. That’s the main reason Graham proposed the margin
of safety in the first place when acquiring shares below its intrinsic value.
This margin of safety can be scientifically computed based on those factors
which may have adverse effect on its intrinsic value such as human error.
Moreover, you are buying at your objectively clear criteria without reference
to market. This is the whole idea of investing; that you are not led and
dictated by the market, but the market becomes your slave instead of your master,
in making handsome profits.
As a result, value investing demands analysis of both quantitative and
qualitative approaches while mindful that past performance cannot guarantee
future performance. What matters most are both the leading financial and
operational indicators. Looking beyond financial statements objectively will
enhance your understanding of a firm’s operational, financial and strategic
plans and help ascertain whether company is building its core competencies to
sustain its business growth and profitability. Companies that achieve a
high return on capital are likely to have a special advantage that keeps their
competitors from destroying their ability to earn above-average profits.
Thus you are able to ascertain with much certainty whether you are
buying good businesses that can truly enhance your investment. This is in line
with Buffet's two golden rules; not to lose money and obey the first rule at
all times. On the flip side, it is also preserves your capital in the sense
that the stock you invested in has more relative stability of assets, if you
have done your homework well especially if you use the worst case scenario of
liquidation valuing method in establishing your intrinsic value.
DOWNSIDE RISK IS LIMITED
For the above reasons, we believe that the downside risk is limited.
This is because we attempt to defend against significant losses while seeking
reasonable returns. That's how our strategy was initially created and crafted
for. While it is tempting to try to capture all of the upside of a bull market,
being caught in the potential downside will result in holding the stock for a longer
term. Thus, these two approaches are much more thoughtful and preferable in
view of much higher possibility in reaping its profit.
Once you are clear of your investment’s purpose, you
will tend to play your game with more focus on the process that delivers your
end result, rather than chasing hot stock without any clue like many investors
do. By eliminating your emotion and temptation, you will tend to have better
control of yourself and your game. Being disciplined and being more patient will
become your investing character. You will tend to follow your roadmap in
picking your stocks that meet your criteria. You are able to be wired for
making prudent investment decisions. To manage our investment well, we need to
make sound decisions and to implement them efficiently.
QUALITY
DECISIONS
Managing by results is mechanistic. Management for
results and by the right process is a better choice. Managing by results only
focuses on the returns of our investment. No specific primary attention is
given to the means of achieving the ultimate goals. Value investing is more
inclined to the process of investing, which forms the key to success.
To hit the bull’s eye, you must align the sights of
your gun with the target. The sights are the means by you hit the target. You
must focus on the sights and accept the relative haziness of the target. Rewire
your mind to focus on the results you want to achieve, or focus on the process
of buying stocks which are in line with your direction toward your goals. Quality
decisions are the way that leads to achieving your ultimate goals, provided they
are effectively implemented.
EFFECTIVE
IMPLEMENTATION
We should leave nothing to chance when it comes to
crafting and implementing a high-quality investment programme that delivers
predictable earnings and dividends. To ensure that you reap the fruits fully,
the right thing must be done at right time, in the right order, at the right
intensity, and in the right sequence. You must do things right, rather than
just do the right things.
INTENDED
PURPOSE
The drive must come from the ultimate purpose we
intend to achieve. By then it will keep us directing our energy and efforts in complying
with the process with ease. The profits come from the opportunity. The process
must be able to direct us to focus on identifying the opportunity. Thereafter,
it enables the investor to realise his investment once the stock price hits its
intrinsic value and above. It sets a very clear framework for every entry and
exit point of its investment. However, it gives some room for the investor to set
his own investment portfolio based on his available fund. The result is less
important to the entire process. Therefore, this systematic approach does not
leave the entire investment to chance, but rather is guided by profound and
sound proven principles and best practices. Ultimately, it is closely
associated with shaping the investor with appropriate required investment skill
and behaviour that generates consistent and persistent profits. In other words,
sounds decisions, with efficient implementation will lead to sound investment
behaviour. That behaviour makes the significant difference. This behaviour will
not be influenced by the daily fluctuation of the stock. These repeated processes
delivers the ultimate results and not by chance.
