Among all the sources of risk that an equity investor face, some need to be addressed at the portfolio level (Correlation, Concentration, Liquidity, and Leverage) and the rest at the individual position level (Low Quality, High Volatility, and High Valuation). Among the ones that must be controlled at individual position levels, a thoughtful investor would welcome Low Quality and High Volatility but avoid High Valuation consciously. Why so?
- Low Quality: Result of factors such as leveraged balance sheet, limited opportunity size, limited longevity of the business, questionable management’s integrity, and lack of disclosures (both qualitative and quantitative). This risk could be welcomed as an opportunity if the price paid reflects excessive pessimism and one holds multiple such positions in the portfolio.
- High Volatility: Driven chiefly by external factors that are uncontrollable - Investor sentiments, Interest Rates, Inflation and may be 1~3% due to company-specific factors. This could be welcomed as an opportunity to buy more when the sale starts if portfolio-level risks are well addressed.
- High Valuation: This must be consciously avoided as it makes one panic and capitulate during stressful market environments, which are bound to happen sooner or later.
| Subscribe To Our Free Newsletter |
