Excerpt from Profits for the Long Run: Affirming the Case for Quality
Low-risk investing is one of the hot topics in equity investing these days. This is a far cry from the environment that prevailed when we launched the Quality Strategy in early 2004. Back then, low-risk investing was a nascent concept. Arguing that risk was priced backwards was a rarity in our industry (although, oddly, it was more accepted in academia). With the passing of time, the benefits of low-risk investing have become more widely accepted. Today, a wide array of low-risk strategies is now available.
Of course, it should be absolute risk on a forward basis that one seeks to minimize. We differ with many practitioners in how this is best achieved. The vast majority seem to follow a quantitative approach to risk, obsessed with its measurement rather than its meaning. Yet, as our colleague James Montier consistently argues, risk is a multifaceted concept, and it is foolish to try to reduce it to a single figure. Like James, we prefer a more fundamental approach. We believe, and have to date demonstrated, that the best ex-ante indicator of low forward absolute risk is found not by studying historical market price data, but through the study of corporate profits. This harks back to the way in which Ben Graham talked of risk. He argued that real risk was “the danger of a loss of quality and earnings power through economic changes or deterioration in management.”