How to mitigate permanent loss of capital

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#1
All investors worry about risks. If you are a long-term fundamental investor, I am sure that if you have been told not view short-term volatility as risk. Rather you should view risk as a permanent loss of capital

The problem with permanent loss of capital is that there is very little literature on what to do about managing risk.

In the case of volatility, there are tons of literature about how to manage them.
  • We have Modern Portfolio Theory that separates risk into systemic and non-systemic ones. You reduce the non-systemic risks via diversification. You cannot get rid of systemic risk.
  • There is the Capital Asset Pricing Model where you have Beta as a measure of risk. You seek higher returns for taking on higher risk.

But when it comes to permanent loss of capital, there is very little advise of what to do. I faced this problem when I started to invest.

[Image: Risk-mitigation-approach.png]

I eventually tapped into my corporate risk management experience to set up my permanent loss of capital mitigation framework. This involves the following:
  • Identify the causes that can lead to the risk.
  • Assess the risk in the context of the impact and the likelihood of the occurrence.
  • Formulate the mitigation measure to manage the risk.

The strategies to manage them cover:
  • Avoid - what can be done to prevent it from happening.
  • Reduce - how to minimize the impact of any risks.
  • Transfer - is there a way to transfer the risk and/or the consequences to another party.
  • Accept - in some instances where the cost of mitigation outweighs the benefit of the mitigation strategies, it may be better to live with the risk.

If you want to know more, refer to ”How to mitigate permanent loss of capital in an awesome way”
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#2
OPMI (Outside Passive Minority Investor) is a pretty lonely affair. So I am not sure if any sort of corporate frameworks would be useful. There are little peers, buddy checks and balances for normally a "One Man Operation".

I thought the best way to mitigate permanent capital loss, is actually to make permanent capital loss. Make them when you have less capital, less leverage and less ego. In essence, when one is younger with less of everything that makes it dangerous to capital losses, there is however better mental flexibility to accept ideas/lessons that conflict with existing ones.

And when we have more capital, more leverage and more ego, hopefully by then, we have attained sufficient wisdom to continue to mitigate such permanent capital losses via learning from other people's mistakes (but they pay for it).
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#3
Whether you have lots of capital or little capital, you will face uncertainty when you invest. As such there is always the threat of losing some of your capital. It has nothing to do with experience or wisdom. It is the nature of investing. That is why I have my risk mitigation framework
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#4
When I was learning about fundamental investing, I was advised that I should not view volatility as risk. Rather I should consider risk as permanent loss of capital.

The problem is that if you don't view volatility as risk, you have problems reconciling using CAPM to determine the cost of capital. You also have problems using MPT concepts.

Worse still if you don't have holding power, volatility can lead to a permanent loss of capital.

[Image: Slide3.png]

It was a dilemma that took years for me to reconcile. Nowadays I consider both volatility and performance loss of capital as different perspectives of risk. I have a risk framework that encompasses both.

I now happily use CAPM, MPT together with my risk mitigation framework to manage investing risk.
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