The Many Faces of Risk

There are many different types of risk involved in the portfolio management process. From an overall perspective, we must always take into account the risk of loss. Seth Klarman, who has one of the investment industry’s most enviable track records, once described risk in this way: “Risk is not beta or standard deviation…it is how much you can lose on an investment and what the chance is that ‘loss’ scenario is going to play out.” As portfolio managers and fiduciaries, we take a conservative approach, endeavoring to keep the risk of loss low.

When evaluating individual securities, there are risks many risks to consider. For example, when evaluating Energy stocks, we must consider geopolitical risk. Typically, when tensions in the Middle East run high, oil prices rise. Oil prices are inherently unpredictable, so we favor companies with low-cost structures.

Healthcare companies have always faced regulatory risk, as their products typically need government approval before they can be marketed. More recently, the relevance of political risk has increased due to the potential implications of Obamacare and related changes in the healthcare landscape.

Political risk has also become more relevant in the technology sector. Earlier this year, former National Security Agency contractor Edward Snowden revealed the elaborate cooperation between US Internet and telecommunications firms and the nation’s intelligence service. Subsequently, concerns have been raised about whether or not the fallout from this incident would cause US technology companies to face new challenges selling their goods and services.

Based on information reported to date, companies offering cloud-based services have not been materially impacted. However, there has been some effect on companies selling hardware. It is not yet known whether or not this situation will continue. It is also possible the Chinese government could be using the fallout as an opportunity to boost the fortunes of those Chinese companies that are able to compete with foreign counterparts, particularly as it relates to telecommunications equipment.

At BWFA, we will continue to take these risks into account in the portfolio management and selection process.