Investment Risk (Part 3 of 3): Actual Versus Perceived Risk and How Risk Can Be Mitigated Over Time
When CarpediaCapital considers investment opportunities, we always frame the potential for returns against the magnitude of risk we are taking to ensure this relationship is appropriately balanced.
To describe our view of this concept and means of implementing it in our investment decision making, we are writing a three-part series on investment risk. The first part discusses our view of what risk is and how much of it to take, the second describes how we take risk and the third discusses the difference between perceived and actual risk and how we mitigate risk.
Below is the third part to our series on investment risk:
Actual versus perceived risk: All investments have some degree of risk associated with owning the asset, and it is the amount of such perceived risk a the time the investment decision is made that drives the returns expected by investors and therefore the price they are willing to pay for the asset. However, Carpedia Capital believes that the actual risk of an asset, as time passes, is not always equal to the risk perceived by investors at the time an investment is made. We have observed that this disconnect in markets, which is frequently the result of asymmetrical information amongst investors, creates opportunities to acquire attractive assets at prices not reflective of their true risk. Therefore, those with a unique understanding of the history, context and potential for accretive change of a business or investment are much better positioned to gauge its true risk and to act with certainty (or know not to act) when opportunity arises.
Can actual risk be mitigated? We believe the most effective means, over a period of time, of mitigating the actual risk of an investment is to ensure it (e.g. a business) is performing better when you want to exit than it was when you entered. In our experience, the most consistently strong performing investors, especially in private equity, are those able to repeat-ably deliver improvements above and beyond the trend in baseline results, typically through strong and proactive involvement to sustainably improve operational, and therefore financial, results. A proprietary view on the opportunity for such accretive change, above the baseline trend, and being able to actually implement such change is critically important to successfully mitigating risk (and therefore generating favourable returns).
Conclusion: Carpedia Capital’s investing strategy focuses on optimizing how we take actual risk – by emphasizing opportunities where, by virtue of our background we have unique expertise or are able to identify companies most likely to benefit from the Carpedia approach to building better businesses – in order to ensure a high likelihood that the actual risk of an investment can be mitigated over time from that perceived at inception. We believe this investing approach is most likely to generate consistently favourable returns relative to the risk we take when making investments.
We welcome, enjoy and encourage feedback from our readers – on this or other investing topics. If you have a comment or would like to discuss further, please submit your perspective to firstname.lastname@example.org or contact us.