Understanding Risk

May 2, 2018

Understanding Risk


By Rich Erwin & David Yepez, SELECT Strategy Portfolio Managers


January 2017


Some of the primary goals of investing are maximizing returns and controlling risk. Managing these two often competing goals is essential for building wealth and protecting portfolios from permanent capital loss. Investing always deals with estimating future outcomes, and the variability of those outcomes enhances risk.


Risk is present in bull markets, but it generates the most investor concern during tough times. Protecting portfolios from unexpected events is important to survive periods of high volatility. As Warren Buffett (famously said), “Only when the tide goes down do you discover who is swimming naked.” 1


So, how does one limit exposure to uncertainty? The core premise of Exencial’s SELECT strategy is to control risk. The term for this analysis is risk/reward2. Each company selection is deeply researched for downside risk, financial strength, management capability and competitive advantage. We understand that the future is impossible to predict, but we strive to always be prepared for market downturns as well as increases.


As we study hundreds of companies, only a few earn our designation of SELECT. We believe market leaders typically generate the greatest profitability. Examples include Facebook (FB)3, United Parcel Service (UPS)4, BlackRock (BLK)5, Disney (DIS)6 and Colgate (CL)7. We also prefer companies with strong balance sheets. That means, in addition to maintaining superior profit margins, they usually have modest debt levels and strong cash positions that help them stay the course during recessions.


We focus on industries within key business sectors that generate consistency of return over full business cycles. For instance, within the technology sector, we prefer software and service companies over computer hardware and semiconductor manufacturers that are very sensitive to economic changes. Within industrials, we like diversified product companies, such as 3M (MMM)8 and Johnson Controls (JCI)9, over metals and building product manufacturers that tend to wilt quickly during slowdowns. Finally, in consumer cyclicals, we favor restaurants, athletic shoe manufacturers and entertainment content providers over auto manufacturers, airlines and homebuilders that often require long uninterrupted stretches of growth to prosper.


The bottom line is we are very careful in our investing decisions and favor certainty, consistency and financial stability over trying to capitalize on volatility. This means there are periods in a bull market when investors that choose to concentrate in high-growth areas or be more speculative may generate higher returns than the SELECT strategy. When airlines are suddenly filling their planes, home construction is surging and semiconductors are in demand, their stocks will usually take off. On the other hand, the reverse occurs when business activity slows or markets become volatile incorporating new and different economic information.


We’d rather own companies that make solid progress in good economic times and weather slow or negative economic growth without suffering debilitating setbacks. In our experience, over entire business cycles, these companies will be able to generate above-average profit margins and good, sustainable returns for investors. This is the risk/reward profile we find compelling.













This article contains general information that is not suitable for everyone. The information contained herein should not be construed as personalized investment advice. Past performance is no guarantee of future results. There is no guarantee that the views and opinions expressed in this newsletter will come to pass. Investing in the stock market involves gains and losses and may not be suitable for all investors. Information presented herein is subject to change without notice and should not be considered as a solicitation to buy or sell any security.


Exencial Wealth Advisors, LLC (“EWA”) is an SEC registered investment adviser with its principal place of business in the State of Oklahoma. EWA and its representatives are in compliance with the current registration and notice filing requirements imposed upon registered investment advisers by those states in which EWA maintains clients. EWA may only transact business in those states in which it is registered, notice filed, or qualifies for an exemption or exclusion from registration or notice filing requirements. This brochure is limited to the dissemination of general information pertaining to its investment advisory services. Any subsequent, direct communication by EWA with a prospective client shall be conducted by a representative that is either registered or qualifies for an exemption or exclusion from registration in the state where the prospective client resides. For information pertaining to the registration status of EWA, please contact EWA or refer to the Investment Adviser Public Disclosure web site (www.adviserinfo.sec.gov).


For additional information about EWA, including fees and services, send for our disclosure statement as set forth on Form ADV from EWA using the contact information herein. Please read the disclosure statement carefully before you invest or send money.

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