We get asked this question a lot these days and my guess is that most people think of risk as volatility. I disagree. I, along with other Trimark portfolio managers, look at risk as the potential for permanent loss of capital – losing money.
When investing in a business, there are really three ways you can lose money:
- Balance sheet problems, leverage
- Fundamental changes to a business
Overvaluation. During the tech boom, for example, people were buying Cisco* at 100 times earnings. Sure, it’s a great company, but when you buy a company at that kind of multiple, you’re never going to get your money back.
Balance sheet problems. If you invest in a highly leveraged (too much debt) company that is forced to raise equity or is pushed into bankruptcy because of balance sheet issues, that’s permanent loss of capital. You’ll never get your money back in those situations.
Fundamental change. What do I mean by this? Newspapers and the Yellow Pages* are two great examples. These were great businesses for a long time, but the rise of the Internet changed everything and has forced many of these businesses to change or get left behind. So investors who bought into them 5 or 10 years ago just aren’t going to get their money back.
When our team is making investments, these are the pillars we focus on when we think about risk. We try to avoid buying overvalued companies, we obsess over balance sheets and we gauge the sustainability of a business, the industry and the long-term growth pattern.
It’s not about volatility.
But…if you still want to use volatility as a measure of risk, take a quick look at this chart.
We may not focus on volatility, but by buying the sorts of companies we believe represent less risk, our small-cap funds subsequently have much lower risk metrics – lower standard deviation, better Sharpe ratios*** and lower volatility of the fund as compared to our peers.
* The above company was selected for illustrative purposes only and is not intended to convey specific investment advice.
**The down capture ratio measures how well or poorly an investment manager performed relative to an index during periods when that index has dropped. The lower the down capture ratio, the better.
***Sharpe Ratio measures your excess return on an investment for the amount of risk taken. The higher the Sharpe Ratio, the better.
Learn more about the Trimark Investments team.
Trimark Canadian Small Companies Fund, Series A provided the following performance returns as at September 30, 2012: 1-year, 15.42%; 3-year, 11.55%; 5-year, 2.64%; 10-year, 8.18%.