I think this was the Gardner piece on risk you were looking for...
tekboy/Ares@Ibuyitpartly,butnotentirely.org
fool.com
Risk-Adjust That Moonshot
...because we've never ACTUALLY touched the moon
By David Gardner
April 4, 2000
The Rule Breaker portfolio continued its market underperformance Tuesday,
consistent with our marked decline ever since Celera began to descend from
$276 at the end of February. Dropping another 9% today, Celera touched down
around $73... off a whopping 74% from its high of just six weeks ago. The
BreakerPort was off 2%.
Six weeks ago, the Rule Breaker portfolio was riding high, up 26% for the year
2000 versus 19% for the Nasdaq and -2% for the S&P 500. My, how things
have changed. We closed today off 11% for the year, with both the Nasdaq
and S&P 500 up 2%. The Motley Fool's NOW 50 index is up 4.5% for the year.
We are losing.
In fact, if you check Fool.com's Investing Strategies front page (you can
bookmark this and click into it any time of day for live updated numbers), you'll
see that ours is the ONLY portfolio tracked in that section that is actually down
for the year. At present, we're being routed. Routed, just six weeks after we
were the undis-PYOO-ted cham-PEEN.
Which is as good a time as any, I s'pose, to talk about risk.
RISK.
Have you ever watched a stock you held drop from $276 to $73? I have. A
bunch of 'em. I've watched some (like America Online) drop like that and come
back and never look back. And others (like ATC Communications or Iomega),
I've watched drop like that and never come back at all. In all these cases, I
owned the stocks through the drops. And in all of these cases, the results were
unique and different. It is part of the fabric of Rule Breaker investing, homespun
threads in a hand-stitched quilt.
Is Celera America Online, or is Celera Iomega?
But we're talking about RISK.
There is this funny thing that academics and mutual funds latch on to, and it's
called "risk-adjusted returns." The idea is that your returns aren't ACTUALLY
what they are -- what you thought they were. They have to be
RISK-ADJUSTED. Only then are they really "the truth."
How do you measure risk? Great question. A great question to which I don't find
any completely satisfying answer. I'll tell you how "they" measure risk: through
volatility. The idea is that risky stocks are VOLATILE stocks. The more a stock
runs up or down, or up AND down, the "riskier" (and more in need of
adjustment) it is.
And so you'll invariably find, when looking at risk-adjusted returns, that
outstanding portfolio performance is adjusted DOWN, while mediocre or outright
poor performance gets adjusted UP. In a year in which, say, the S&P 500 rises
9%, it was far "safer" and less risky to have your stocks move up 7% rather
than 37%. That 37% needs to be "risk-adjusted," because those stocks that
ran up so far above the market did so because of their risky volatility, and that
needs to be wrung out of the performance numbers. The manager obviously
took above-average risk in volatile stocks, so OF COURSE he or she
outperformed the market.
I have heard such talk for some years, now, and I do not begrudge most of it.
The use of "beta" -- which is a measurement of volatility somewhat similar to
what I'm discussing above -- is not useless. Knowing a stock or a portfolio's
beta (a simple measure of its volatility relative the market's average volatility)
does give a prospective investor some insight into the extremity of swoops and
dives made by the prospective investment.
But when we begin to adjust actual, real-money returns in order to "iron out"
the risk and show that you didn't ACTUALLY make or lose as much as you
actually did, that's where I hop off the wagon. Because, you see, I don't view
risk in the same way as these conventional thinkers. Risk is not beta.
The real risk in a stock like eBay is not how much or how frequently it rises or
drops; it is the degree of relevance and defensibility of its business. eBay, to
my way of thinking, is an extremely defensible business model, quite a
dependable long-term investment. eBay is so solid within its market -- and its
market is so important and relevant -- that eBay actually puts the REAL risk on
the shoulders of all its competitors. Take Christie's, or any other traditional
auction house. THOSE are the companies that have lots of risk. The academics
with their cocked compasses who tell you a stock like eBay is risky while
Sotheby's is not are using the wrong tools to measure.
And I don't want that to sound too critical, because I actually like academics.
Much good work has come out of academe for investors, including the
University of California-Davis's study showing that patient investing beats
day-trading almost every time.
Risk-adjusted returns. For these things, I have little patience. I think it helps us
to see through them when we put them in another context. So here you are:
Risk-adjust the Apollo Mission and man never touched the moon.
You see, he took crazy risk even to attempt it. So much risk that when you in
fact adjust for it, you find that he didn't deserve to touch the moon. So it
doesn't count. Indeed, until we find a simpler, completely dependable way to
transport ourselves those 238,000 miles, man will not have touched the moon.
(On paper.) Stick with managed mutual funds, not Cape Canaveral.
Yes, managed mutual funds are generally the biggest fans (and most obvious
beneficiaries) of risk adjustment. Many of them own scores of stocks, often
"safe" stocks (purchased by backward-looking and backward-thinking
managers). When Morningstar adjusts their returns and gives them high marks,
they begin to look much better than they were. You see, they took so much
less risk to underperform the S&P 500 than some of the things that
outperformed! They were less volatile. How comforting.
I spent last week skiing outside Aspen, Colorado. In Aspen, I spent one night at
the Crystal Palace, always an entertaining night out as you are treated after
supper to a medley of sardonic songs containing original poison-pen lyrics about
the figures and events of our time. New stuff every year. If you're like me, you
giggle most of your way through.
But the director always makes a point of including one disarmingly sincere,
almost sentimental song, generally toward the end. This year, it was called
"Stars and the Moon," and I watched Reba McIntyre go up to the director after
the show (she was there that night) to find out who wrote it and how she
might find the lyrics. It was sung by a woman who in so many words says that
she found the perfect man, who offered what anyone (I suppose) wants: the
stars and the moon. BUT, she wanted a yacht. So, being the perfect man, he
gave her that. And he gave her a chateau in France, and he gave her lavish
food and friends, because she wanted those, too. And he gave her a Hollywood
jet set she could mix with every night. He gave her stars. But as the song
unravels at the close, she says that despite all of this, she has finally realized
at the end of it all:
"I'll never have the moon."
Will Celera come back or will it underperform the market, having caught only the
briefest flash of light under a waning crescent moon? I have my own thoughts
about that, as someone who continues to hold the stock.
But whether or not you hold that stock, whether or not you hold any stock at
all, if you risk-adjust reality, if you pat yourself on the back for taking a safer
tenth-rate when you could have had the first-rate, we can say this for sure:
You will never have the moon.
Fool on,
David Gardner, April 4, 2000 |
