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Risk Approach

  • Consider risk characteristics under both normal and stress conditions
  • Consider risk characteristics over both short and long horizons
  • Assets with similar short term risk characteristics under normal conditions can have very different risk characteristics under conditions of shock 
  • 10mm of six month GMAC bonds compared to 1MM of 15 year GMAC bonds
  • Assets with similar short term risk characteristics under short horizons can have very different risk characteristics under long horizons 
  • 1 MM in defaulted senior secured bonds backed by aircraft compared to 1 MM position in an S&P 500 index
  • 1 MM in defaulted sovereign bond compared to a 5MM position in 5 year callable AA subordinated bank bond
  • Deeply undervalued securities will typically have similar short term risk to fairly valued securities but dramatically lower long term risk
  • Cash producing securities with similar short term risk to non-cash producing securities can have lower long term risk on account of lower exposure to valuation risk.
  • Diversification may decrease specific risk exposure but not exposure to market wide events and shock
  • Large positions in deeply undervalued assets increase specific risk and short term risk but could lower long term risk of permanent impairment of value