Investment Management – Risk vs. Return

Investment Management – Risk vs. Return

investment management risk return

“The essence of investment management is the management of risks, not the management of returns.” – Ben Graham

Investment management is generally defined as the professional management of various classes of securities—typically equities and bonds—in order to meet each individual client’s specific investment goals. At Sprung, our investment management approach is based on the value investing principles developed by Ben Graham.  Graham explained that “the essence of investment management is the management of risks, not the management of returns.”

That approach may seem counter-intuitive to many investors—and their advisors. They assume that investment management is all about managing returns. Many expect and even demand that their advisor out-perform market indices. What they fail to understand is that by doing that, they are in fact taking on more risk. If a fund out-performs in a rising market, it will likely under-perform in a declining market. This is exactly what many Canadian investors experienced in 2008: while the TSX Composite Index declined by 33%, many supposedly ‘conservative’ large-cap equity funds declined by 40% or more.

Seared by this experience, many investors pulled out of equities. However, with interest rates at historic lows, they are hungry for income. In response, many advisors have placed their clients into so-called ‘high-income’ funds. Many investors see the word ‘income’ and assume that these are safe, conservative investments. In fact, many of these funds expose investors to significant risk due to a large exposure to below investment grade corporate bonds, otherwise known as junk bonds.

Today, corporate junk bonds provide significantly higher yields than governments bonds, but they contain a hidden risk. As value investors, we tend to avoid date specific forecasts. However, a growing number of market watchers think that Obama may replace Fed Chairman Ben Bernake in August and end his easy money QE policy – read more here. This could lead to a jump in interest rates, causing longer-term bond prices to drop. As rates rise, the ‘spread’ or difference between government and corporate bond rates will widen.

If you own a fund with the words ‘high income’ in its name, you could be at risk.

Our investment management approach shifts focus away from chasing returns. Instead, we seek to reduce risk by focusing on company and market fundamentals by following our three-part value investing strategy:

  1. Appraise the intrinsic value of each company over a business cycle;
  2. Seek long-term growth of capital by investing in companies that we perceive to be mis-priced;
  3. Utilize a margin of safety to promote return of capital…not just return on capital.

We believe that investors are better served by following a value-based risk management approach, rather than chasing the latest ‘hot’ money products touted by many advisors.

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