Redwood RiskFirst™ Investment Philosophy
Quantify and Manage Risk First, Investment Success Follows
Based on years of research and experience, we have learned that Risk, specifically investor reaction to realized Risk, is a primary impediment to investor success. Conversely, we have also learned that properly identified and managed risk is a key to investor success.
At Redwood, we do not attempt to predict risks, or trends, or returns. Rather we utilize proprietary, quantitative, data driven research to drive disciplined processes across risk assessment, risk budgeting, security selection, portfolio construction, tactical decision making, and risk management. This discipline isolates pre-conceived prejudices, seeks to minimize discretionary biases, and facilitates focus on critical characteristics associated with statistical success.
Isolating Downside Risk
Ultimately, investment decisions are made to produce returns on capital. However, expected returns are influenced by the associated risks and even more by investor behavior relative to realized risks, such as locking in losses when an investment has depreciated. The Redwood RiskFirst™ philosophy takes an investor-behavior centric approach to identifying and analyzing risks. This begins with a focus on isolating the risks of actual loss of capital associated with any potential investment.
Many investors encounter difficulties attempting to understand potential risks due to the wide range of now common investment statistics and analysis tools at their disposal. One example is the unfortunate wide spread use of the statistical measure of volatility, standard deviation, as the primary identification of risk. At Redwood, we don’t accept or rely on consensus thinking, we dig deeper with our own research to find the answers the data and analysis provide. In the case of volatility, it is critical to isolate and analyze downside risk separately from upside risk even though they both contribute to the more common standard deviation measure. We utilize incremental risk metrics such as downside deviation and notional value drawdown risk, combined with forward looking simulations and metrics such as VaR (Value at Risk) to identify and isolate downside risks. This research provides the foundation for all of our investment strategies. For our strategies that can own greater risk of loss securities like stocks or high yield bonds, especially strategies that have a goal of protecting against significant loss of principal, this downside risk analysis plays an important role in our execution of tactical risk management.