Discover the basic concepts of needs analysis, investment policy, asset allocation, product selection, portfolio monitoring and re-balancing. We will look at the types of institutional investors - pension funds and insurance companies. You will learn the client management life cycle and dive into portfolio management as a process. You will learn the basic concepts, principles, and the major styles of investing in alternative assets. Finally, we study the impact of digitization on investment strategies.
4.1 Permanent loss of capital
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来自 Indian School of Business 的课程
Investment Strategy
29 个评分
从本节课中
Risk
After completing this module, you will understand the meaning of permanent loss of capital and you will also be able to evaluate the performance of funds. You will also get a clear understanding of distributional approach to investing in assets.
与讲师见面
Vikram KuriyanClinical Professor of Finance
Director, Investment Lab
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Learning Outcomes.
After finishing this video, you will be able to define permanent loss of capital,
understand when to use permanent loss of capital.
We have enough background to move into the nuances of investments, and
particularly I want to get into some nuances about risk.
All most important propositions of modern finance
put against the notion of risk and return.
We take as invaluable the action that higher returns are accompanied
by higher risk, and vice versa.
And that risk and return cannot be decoupled.
But things may not be as straightforward as that.
Fund managers, of course, are running off of the Holy Grail,
trying to generate pure alpha, superior risk adjusted returns that
stem from expert asset and security selection market timing.
Then, madly pursue assets whose movements are uncorrelated to each other so
as to keep to a minimum.
These are useful and extremely important for short horizon investors.
However, they have a flaw.
And sometimes what happens is asset correlations change over time and
change in different environments.
So all this is important for short horizon investors.
But long horizon investors may, in fact, have a different view of risk,
a view of risk that's not so dependent on standard deviation.
So I want to introduce you to another perspective, another concept to look at.
This concept of risk is well conceptualized by
the phrase permanent loss of capital.
Now, volatility is easily quantifiable and hence is often used as a proxy for risk.
But volatility itself has different definitions.
What is termed as one-day volatility
can be markedly different from one-week volatility or one-month volatility or
one-year volatility or ten year volatility.
So there's a time dimension even to volatility measurements.
So this notion of time horizon is an extremely important idea.
Volatility as defined by a movement in prices can come in many shades.
One issue is that of mean diversion.
Short foreign fluctuations can be smoothed out over longer time periods.
Particularly in mean reverting time series.
Consider the following daily price changes of the S&P500 over different
time horizons.
The plot above shows percentage changes in daily prices
of the S&P500 from March 1950 to April 2016.
16, 700 days.
As we can see, the main percentage change in daily prices is almost zero.
And even though the S&P was at 16 in 1950 and
over 2,000 today, the daily movements seem pretty static.
The plots below show percentage changes in daily prices in 6 randomly chosen,
30 day samples for the same data set.
A long-term investor would not be bothered about these short-term fluctuations.
As he knows, these variations ultimately revert to long-term intrinsic value.
In creating risk to these short term prices, these short term movements
may not be appropriate as it is nearly quotational loss.
But since long term investor does not plan to change his portfolio,
there is no longer an economic loss associated with it.
He is more concerned about the second type of price movement,
One which does not allow him to recover his capital in case of an adverse shock.
What do we mean by this?
Permanent loss of capital occurs when volatility or
economic events, kill the way your money gets compounded over the long term.
Consider an investment of a $1,000 over a 10-year time period, and
that compounds annually at 10%, which has been the rate of the S&P over a century.
After 10 years, the final value of the corpus would be $2,400.
If there's an adverse shock to the portfolio,
that leads to a 50% decline in year 6.
Then, the corpus at the end of the year 10 would be just $1,000.
This investor would just about recover his capital at the end of his
investment horizon.
And assuming no further shocks,
it would take him another 9 years to get to the $2,400 number.
If this was a firm he'd invested in, Where would his investment lie?
If the firm goes bankrupt or if it's earnings power is permanently impaired.
The answer is obvious.
In a firm, you'd have probably lost his money.
This is the view of risk propounded by value investors in the mold of Ben Graham
and Warren Buffett.
The risk of permanent loss of capital.
Adverse shocks can lead to permanent loss of capital in yet another way.
The fire sale of stocks at rock-bottom prices at the wrong period of time.
Permanent loss of capital can be avoided if one chooses to invest in indices or
in businesses that have the following characteristics.
Low-leverage, Consistently high free cash flows,
strong financials, and wide moats from competitive threats.
In the short run, drawdowns are inevitable and
essentially notional unless the holdings are sold.
At which point, if this occurs, losses are locked.
But healthy businesses such as the ones we just mentioned
Prices are likely to bounce back.
As a canonical example, take Berkshire Hathaway.
A company controlled by Warren Buffet.
Since he took over, the stock price has suffered many price drops.
In the late 90s, in the financial crisis, 2011 and even last year.
But the stock has bounced back repeatedly and
the overall trend has been consistently upward.
It has had 3 drawdowns of 50% from peak to trough, since Mr.
Buffet took control of the account.
But the declines in quarter price had no effect on him, since he viewed these
declines as merely quotational loss and not permanent loss of capital.
This is the key idea behind the idea of permanent loss of capital,
are drawdowns due to temporary price movements, or
to permanent impairments, either in the business, or in the country,
or in the underlying characteristics that make up that investment.
People who have long time horizons may have a different view risk,
a view of risk different from quotational movements.
And many of the great investors have this concept of risk
as permanent loss of capital.
There's a rule of thumb that sort of says that,
in the long run the market is a weighing machine.
In the short run, it's a voting machine.
The rule of thumb sort of says that it takes three of more years for the weighing
characteristics of a market to be apparent over the voting characteristics.
As an example, to give a sense of how long you need
to consider times for weighing characters,
come and look at the S&P 500 since 1962.
3 year returns on the S&P 500 are negative nearly 30% of the time.
One needs to be invested in the S&P 500 for
12 years to almost always get historical returns from the past
Before I conclude, I need to reiterate one important point.
Discussing risk in the absence of a time horizon is meaningless.
Investor's time horizon is absolutely essential to understanding his or
her capacity to handle risk.
If you need to access all your money quickly and
how they avail low time risk tolerance and
the prospect of the short term coded price decline is your definition of risk.
Of your time horizon is long, your view of risk is more nuanced.
You should measure risk, as a decline in unit price,
measured over a long period of time.
And by that definition, permanent loss of capital may be your definition.
Many long term investors, value investors, and private equity in particular, because
after all, private equity doesn't have a market to markets like in public markets.
They view risk through the lens of permanent loss of capital.
Many endowments and sovereign wealth funds use this mindset to argue,
that their big advantage over other investors,
is the ability to withstand market to market fluctuations,
because their view of risk is a permanent loss of capital, and
they can tolerate short term fluctuation.
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