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A REAL-TIME LOOK AT RISK MANAGEMENT

On December 2nd I wrote a piece entitled “Gold represents the massive risks in this market“.   I wrote that gold had come to epitomize the reflation trade and the herding of investors into all risk assets.  The yellow metal had gone parabolic and I declared that it was looking bubbly.  You can only imagine how unpopular this outlook was with the vast hordes of investors who had piled into gold over the last few weeks.  My email inbox was flooded with angry investors who viewed my call as a personal insult.  It was the farthest thing from that.  Rather, it was nothing more than a risk management call.  I have no position and had no position in gold, but from a risk management perspective it looked like an incredibly risky asset to be toying around with (bear in mind, this was when gold was trading 8% higher than it is today). I made no money on the call.  It was by no means a great call.  It was a nothing call so please don’t view this as me tooting my own horn.  But from a risk management perspective, the idea that you should simply avoid gold at all measures was the right call.

I am a firm believer that risk management separates good investors from bad investors.  Anyone can ride a trend or run your standard 90% long equity mutual fund, but where does the alpha come from in these portfolios?  Real alpha comes from superb risk management.  And in most cases this is knowing how to avoid the steepest losses.

The arithmetic behind declines is quite simple.  If you lost 50% of your portfolio last year (as most investors did) you now require a full 100% gain just to get back to even (staggering isn’t it?).  So even if you remained fully invested throughout the recent downturn (where you lost 50% and then made 60%) you are still down 20% from your starting point.

The point here is that sometimes the best move is not long or short, but rather no position.  Like a good poker player, the best investors only make bets when the odds are in their favor and avoid playing when the odds appear stacked against them.   Feeling like you always need to be involved in the market is the wrong approach.  Rather, knowing how to avoid the landmines is the best path to success.

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