DEAR readers, since this is my first time being with you, I would like to commence by wishing you all a happy new year and all that’s good for 2013. May this be the year that you make all the decisions necessary for your dreams to become reality. Reflecting on 2012, and the first weeks of 2013, one is acutely aware of pending issues such as Eurozone bailouts, the US Congress hitting its head on a debt ceiling, and a Jamaican Government facing onshore challenges and offshore scepticism.

Despite all this, I happen to have first-hand knowledge of investors who netted north of 10 per cent on the US dollar in six months during 2012 despite all that abounded. It is important to note that the ‘what’ in these instances pales in comparison to the ‘how’ these were accomplished. The clear and present reality is that this is an environment of elevated risk. Bearing this important note in mind provides a seamless segue into the concluding instalment of my three-part risk series; ‘the mitigation of risk’.

To build on parts one and two of this risk series, and my ‘Diversification’ article of 2012, appropriately mitigating, or managing (not minimising) risk is achieved via a few means, which include:

1. Identifying an exit point at the time of investing: This is commonly practised by private equity firms in LBOs (leveraged buyouts) upon embarking on closing a deal. The preferred means are exits by way of the public sale of the shares in the company via an IPO, a private offering of shares to interested parties (private placement), or through the sale of the company to a bigger private equity firm. The value for a retail investor is clear, for whether investing in equity or fixed income it is critical to mentally establish a resale yield/price for the instrument in question.

2. Investing in sectors which have relatively inelastic product demand, regardless of circumstances: sectors of this nature include utilities (electricity, energy, water), apparel — for unless we return to the Garden of Eden, man will continue to wear clothes — and telecommunications.

3. Buying low relative to fundamentals such as book value and price to earnings ratio (PE ratio): This presents a wider margin of safety (Faithful readers will remember my reference to a bridge, and two cars of different weights as per a previous ‘In the money’ contribution.)

4. Not perceiving investments as being isolated from an individual’s ‘real life’: This essentially means, treating a client’s stake in a company (or companies) as part of their overall portfolio, rather than being separate. This is important for they would be already exposed to the risks of business ownership and as such, one should be wary of going overweight in this asset class. There could come a day where the client would require urgent funds, and as such, giving thought to the holding of easily liquidated fixed-income securities or cash could provide a respite in the event that one has urgent need for funds.

5. Not going overweight in any illiquid asset and exercising true diversification. For example, the culture in Jamaica is placing total (almost blind) reliance on real estate because of the tangibility of the ownership and the physical returns (ie cash) inherent in rental income. While this is reasonable in theory, the reality is that going overweight in real estate could have tremendous liquidity implications if:

The property owned doesn’t produce capital gains — as is the case in Jamaica now, especially with the higher-end variety which many believe would be buying high and as such, lessen their margin of safety.

Another one is having difficulty finding suitable tenants for the premises — this has led to many fire sales when tough times come.

Also having difficulty finding a buyer — real estate transactions can be protracted, especially when compared to the T (transaction date) plus three days for the sale of your typical investment instrument. It is not far-fetched for a sizeable real estate deal to take 12 months to close.

My personal encouragement to those seeking to place funds in the pursuit of capital gains is to fully acquaint themselves with the risk involved with the undertaking. As stated ad nauseam, risk abounds in whatever one does, and the key is to identify it and then mitigate it accordingly. An individual dissatisfied with fixed-income returns, but not comfortable with the exposure of a growth stock, could then look into buying into a mature, established company with strong cash reserves on the stock exchange to take advantage of the growth potential within equities, whilst guarding against the dangers associated with a younger company. If an investment is akin to walking a tightrope, then risk mitigation is the long, narrow beam the practitioners use to balance and ensure they remain on the desired path.

While this draws the risk series to a close, I already look forward to sharing other insight with you in the coming weeks. Wishing you well.

Ryan Strachan is the Manager of the Wealth Division at Stocks & Securities Limited and can be contacted via rstrachan@sslinvest.com