The impact of negative compounding can easily be underestimated; we are mindful that a portfolio losing 50% of its value will need to work twice as hard (i.e. grow by 100%) to recover its original value. We are always “risk-aware” and, when we can, “risk-adjusted”. Either way, risk assessment is an important variable to us. Methodologically, we are keen to make a clear distinction between fundamental risk (the risk to the economic rent or the reinvestment rate) and market, or “behavioural” risk (the risk of a change in market trends or risk appetite).  ValuAnalysis has a long experience in using various methodologies to address and minimise both.

Examples of such portfolios can be found in the following pages, and are recognised by the letter 'S' (for 'Safety net approach') in their names.


Risk Awareness Enhances Returns and Reduces Tail Risk

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  • The above sample portfolio assumes no specific attention to the risk properties of stocks. This is clearly visible in the "tails" where monthly returns of -8% or worse, occur quite often.
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  • This portfolio excludes specific stocks from the sample portfolio using VA's risk assessment methodologies.The "tail" is significantly reduced and the returns are more condensed with a skew to the right.


Risk Considerations at the Core of our Stock-picking and Portfolio Construction

To mitigate fundamental risks, we systematically exclude opaque business models from our investment universe. The replacement value of the economic capital may be too uncertain or leverage may be applied to an uncontrollable degree.  We rank our investable universe on a battery of objective economic measures.  We perform in-depth micro economic analysis on companies to understand the economic characteristics of a business with a focus on the sustainability of economic rent, hidden or explicit balance sheet risks, capital consumption and the growth rate.


We think that the best way to avoid taking too much risk is not to overpay. We focus on the ratio of Enterprise Value to sustainable Free Cash-flow as the most reliable value ratio.  We are likely to shun businesses valued above a certain level of this multiple, regardless of their level of economic rent. To us, valuing a stock in a “risk aware” manner is about making sure that the market price of a company is not discounting above its sustainable return. Combined, these risk mitigation factors help to build portfolios with attractive characteristics. 


As for market risk, there is evidence that the behavioural risk properties of stocks can be analysed and somewhat predicted. This allows us to design optimal portfolios by filtering for essential stock characteristics such as decorrelation, overall lower volatility and reduced tail risk. Integrating potential risk reduction is at the core of our investment decision-making process.


Ultimate Risk Control through Portfolio Techniques

We also offer the possibility to reduce risk further through well-established techniques known to banks, insurance companies and pension funds. These include linear solutions which do not require derivative instruments: dynamic capital protection, continuous capital and return safeguarding techniques, and low volatility targeting to name a few.