Managing Non-Variance Risk Through Capital Preservation

# how to quantify non-fundamental risk if variance is 100% discounted?


# how to quantify non-fundamental risk if variance is 100% discounted?












If there's better vocabulary, forgive me.

If you were required to ignore variance as risk, how would you quantify non-fundamental risk?

Many thanks in advance!

## Answer by Matt Wolf (score 3)

https://quant.stackexchange.com/a/7264

Here couple points that at least helped to formulate a daily guide for myself:

- Losses are just what they are, losses. You return tomorrow to play again. But bankruptcy means game over, you are done. Thus such event is to be avoided at all cost.

- Long-term, equities exhibit positive drift and have outperformed other competing asset classes. However, the path in between can lead any manager, investor, or trader to bankruptcy. Volatility and draw downs can easily bring down any portfolio no matter how little it is leveraged.

- Past performance ironically is often our best predictor of future performance. However, if the conditions that define performance are altered or adjusted to such extent that the prediction stands on shaky grounds then all bets are off. We have entered into an environment that is unprecedented (inability to service government debt without incurring huge amounts of new debt on a global scale; consumers with empty pockets unless they borrow by incurring liabilities in the form of HELs, mortgage debt, credit card debt; a new emerging super power which has not yet shown its true face,...). Point being, there is only 1 or 2 companies remaining in the Dow30 of those that comprised the index a century ago. Look at the S&P500 members 50 years ago and count how many of those companies are still in business today. We are entering uncharted territory and there is no guarantee that any particular asset class will outperform. There is not even a guarantee that inflation will cause damage. Hyper inflation generally went in hand with lose monetary policy (check), a great business environment with high capital expenditures (no), wage growth (no), and consumer price inflation (no but potentially yes). I do not think history will repeat itself or prevail. Thus, more care and respect for risk should be in order.

- I want to protect my assets at all cost, any time, and always put priority on capital preservation over engaging in high risk-high payoff type of trades. I consider myself an opportunist. I have no problem (ideally) sitting on my hands for weeks and not putting capital at risk while searching for the trade that gives me a clear edge. What is the point of exposing myself to potentially catastrophic events over prolonged periods of time if I can wait and enter a trade when probabilities favor such position the most?

- I think Peter Lynch greatly idealized his investment approach. He put in more research and care than anyone else but reading his book and comments it sometimes sounds like he is fine with prolonged draw-downs because he believes he bought something of value. Selling tops and buying bottoms has so far never worked out, nor have I seen academic papers that would suggest such approach is profitable, unless you have so deep pockets or are a public figure that you can either move the market yourself or entice others (Ackman, Icahn, ...) to join your position. Trading against momentum is a losing proposition and I am sure that is not what Lynch advocated. But many self-proclaimed value investors interpret his wisdom in exactly this way.

I finally do not agree with your statement that value investors ignore risk. They do not and should not ignore risk (whether you call it variance risk or anything else does not matter). I simply have not come across a single successful trader or portfolio manager or investor who took the luxury to ignore risk (draw downs, return variations, ...). The smartest and at the same time most successful traders are not the ones who spot the best opportunities but the ones who exhibit the balance between being fearful and vigilant about exposing themselves beyond stringent risk limits and being aggressive and forceful when opportunities of high risk-return value present themselves.