Risk and the Value Investor

The continued adherence to efficient market theory ironically makes the market less efficient. The reason: the data hungry models used to describe optimal portfolio asset allocation equate volatility with risk. The models are indifferent to whether assets are cheap or expensive in terms of current relative and absolute yields.

The obsession with this one dimensional measure of risk may actually work against the prudent man rule. In the aftermath of the 2008 credit crunch, many professional fiduciaries, as advised by their consultants, actually increased their allocation to bonds. They did this even as the benchmark 10 year Treasury Bond yielded 2.5% (a multiple of 40 times "earnings").

The value investor's view of risk differs from the conventional view. A value investors' definition of risk is permanent capital impairment. As Dr. Michael Burry puts it in Michael Lewis's book The Big Short "real risk is stupid investment decisions". Investment success always comes down to one thing: the price paid. Everything is a buy at one price and a sell at another. Risk always increases as the price goes up.