We frequently receive questions around how we think about risk, and how we attempt to control it. We view investment risk as the risk of a permanent loss. We view volatility as a symptom of risk, but not an actual risk.
Risk management is embedded directly into the Prospector’s investment process, not to mention our DNA. The foundation of our investment philosophy is our assessment of downside risk - we first consider what can go wrong. Our emphasis on companies with strong balance sheets that generate free cash flow beyond their reinvestment needs helps the portfolio to weather equity market stress caused by hostile capital markets and/or recessionary economic conditions.
We believe that risk can be managed at several levels. In the security selection process, we focus on the relationship between the actual market price of a security and the intrinsic value of which the security represents an interest. This is based on a bottom-up fundamental value analysis with an emphasis on balance sheet strength, free cash flow generation, and private market value analysis. Another individual security selection risk mitigation strategy is our use of convertible securities. We are attracted to their risk/reward proposition which offers a bond floor protection, should something go wrong, while allowing equity participation on the upside.
The next level of risk management happens at the portfolio construction level where we carefully monitor concentration, sector exposures, average daily trading volume of positions held, and portfolio volatility as measured by beta and standard deviation. An important Prospector maxim is to never “over bet our hand” on any one macro or micro factor.
This blog is an excerpt of our recent Q&A with the Portfolio Managers. We encourage you to explore the 10 other Q&As in the full document, available below. Topics include:
- Why portfolio managers should have their personal assets invested alongside shareholders
- Tips on avoiding Wall Street group think
- How our approach to equities is similar to high-quality bond managers
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