Fountainhead’s risk management policy is based on three key attributes:
1) Defining and identifying risk
2) Avoiding risk
3) Managing risk
We believe in Ben Graham’s definition of Risk. We define it as the permanent loss of capital, or a high degree of temporary loss on investments that generates enough psychological pressure to force the temporary loss into a permanent one.
Here is how we understand the risks our investments are exposed to and why we are taking those risks:
|What we are exposed to||What risks are involved||Why we are taking those risks|
|Macro exposure||Monetary and Fiscal policies, Demographics.||Understanding of deflationary economics provides an edge.|
|Equities exposure||Equity volatility, Equity Drawdown.||At right valuation equities provide extremely attracive returns.|
|Theme exposure||Popularity, Life-cycle.||Socio-economic trends driving our themes are powerful.|
|Sector exposure||Competition, Overcapacity, Regulation, Disruption.||Within our Circle of Competence.|
|Stock exposure||Fundamental, Valuation, Momentum.||Significant capital appreciation possible with fundamental analysis.|
|Size exposure||Volatility, Liquidity, Drawdown.||Profitable business model with a long runway for growth.|
We primarily avoid risk by not investing in what we don’t understand.
Amazon is a great example. While it is probably the most powerful business force in the world at the moment, its price fell twice by 90%, which forced enough people to believe that the company had lost its competitive edge. This is the kind of risk that we avoid and why we don’t generally invest in popular tech stocks.
• Our hedging activity and cash positions are the main tools for managing portfolio risk.
• We are comfortable holding large cash positions if we feel that our portfolio companies are not attractively priced to offer a good risk-return profile over the long term.
• We tend to hedge the portfolio from a large drawdown in equity prices when we foresee one of two conditions developing:
i) recession risk
ii) multiple compression risk.
We primarily use index options to hedge both these risks.