Risk – what does it imply?

26th September 2016
-Asset management, IAM, Gestion de fonds

Erika Mesmer, Client Relationship Manager

Looking at the broad definition of risk it is a probability or a threat that something negative such as damage, a loss or a liability occurs. In financial markets the dominating measure of risk is volatility i.e. the dispersion of returns of a security or an asset class. The higher the measure, the more the price of the asset fluctuates (positively and negatively) and hence the riskier the asset is considered. Although easy to calculate, it is worthwhile to reflect if this is the right way of defining risks.

We at IAM consider risk as the probability of losing the money invested. Looking at equities and investing with a long term investment horizon in mind, our central question is not whether the share price of a company is fluctuating a lot. Our central concerns are rather:

1.- Will the company still exist in the future?

The maximum loss an investor as shareholder of a company can incur is the full amount invested if the company goes bankrupt.

2.- Valuation of the company

When investing in a company, the price paid for holding a share in the company is very important. If you pay a price higher than the underlying value of the company, then there is a strong likelihood to lose money, as the price will overtime align itself with the true valuation of the company. On the contrary, if buying a company when its price is well below the valuation, then there is a potential for upside, with the price catching up with the valuation.

As active, long term and anticyclical investor, volatility can be very positive, when correctly apprehended. A solid company, with a strong management team and positive future prospects is not riskier just because its share price has dropped due to strong market movements. If we are convinced of a company then this fall in price is an excellent buying opportunity for us as anticyclical investors.

Take for example Burberry, a UK fashion company active in the luxury segment, which we hold in the IAM European Equity Fund. While the valuation and the long term outlook for the company have remained unchanged since the beginning of the year, market movements independent from the company itself (worries over growth in China and Brexit) have influenced the share price to move from GBPp 1400 to 1100 and back to 1400. Was the company riskier when it traded at 1100? No. However it was a great buying opportunity!

Prices lower than the projected valuation is what we look for when investing in our Equity Funds. Interested to see more? Why not take a closer look to the IAM European Equity Fund?