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March 25, 2010

Fundamental vs. Traditional Risk Management

When people mention "Risk Management" in investing the traditional metrics of volatility, correlation, Value at Risk, Beta, Sharpe ratio, etc. come to mind. But for fundamental shops (stock pickers) it is difficult to utilize risk management statistics to manage a portfolio. In fact, at my old shop, we would fire up the risk management software on the 30th of every month so we could put the data in our investor letter and that was about it.

The reason is because good fundamental portfolio managers understand that risk is not volatility, it is loss potential. Loss potential is measured by their fundamental research and should be the primary risk constraint. This is a piece that I wrote a while back discussing some of the differences between fundamental and traditional risk management.

I think the concepts are more important today as the number of experts decrying the use of traditional risk metrics grows.

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