Always Bearish, Never The Bull

I invest like Evel Knievel layered in bubble wrap — Small cap markets are the scariest, most volatile public asset class — A risk-first mentality is the only prudent approach when taking the leap.

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ALWAYS BEARISH, NEVER THE BULL

Value investors are generally bearish on the markets, believing that most stocks are overpriced most of the time. The logical conclusion is that the market should fall to correct these mis-pricings.

I fall into this category. I see risk everywhere I look. I am highly risk averse. I worry all the time - about the markets, my kids, my country.

At first glance, a perma-bearish outlook is illogical for an investment manager. Markets go up most of the time. Equity investments are intended to generate return. Missing out on daily, monthly, and yearly gains, especially those enjoyed by your bullish neighbors, is painful.

But, in my view, this bearish outlook is required to generate alpha.

The Scariest Asset Class

I invest in small cap stocks all over the world. There is no more volatile public equity asset class. In fact, with the volatility smoothing practiced in private markets, this may be the most volatile asset class on the planet.

This market should  be approached with extreme caution. I've worked at funds that have owned multiple fraudulent businesses, ultimately worth nothing. I've seen currency moves push investments, in a matter of months, into insolvency. In the last six months, I've owned numerous companies that have seen >20% price moves in a day—both up and down.

My risk aversion may not be high enough when approaching the wild west of public equity markets.

No Predictions

I'm also fully invested in these markets. Although my bearishness may resemble that of gold bugs, cash-under-the-mattress investors, and put buyers, my portfolio cannot escape risk.

I must be >90% invested to serve my clients. I cannot protect my fully invested portfolio from macro swings, regardless of my predictive abilities.

So, despite my bearish views, I am not taking a macro view. Being a fully invested, fundamental investor, my macro views are completely irrelevant - as they should be.

Concentrated Bets

I don't even leverage the value of diversification to tame the volatility of my asset class. When individual stocks swing wildly, so does my portfolio’s performance.

Despite my risk aversion, I do not see diversification as a solution. The only thing riskier than my asset class is investing in low quality, overpriced, and/or poorly managed businesses.

I see more risk in marginal investment ideas than reward in the diversification they bring.

Two Views, One Head

I keep two, contrasting views in my head at all times. I am risk averse. But I put my capital at risk.

Small cap investing is the financial equivalent of jumping a motorcycle over 20 cars. I invest like Evel Knievel layered in bubble wrap.

I approach the challenge with extreme caution, far more than Evel with only his helmet and flame retardant suit. I do not want to break every bone in my body, or lose all my money. Life and capital are fragile and must be protected.

But without accepting risk, life is without return. So I take the jump. With all the protection I can come by, I’m willing to participate in (reasonably) high risk activities. 

To me, this is the only logical approach. After all, life is boring without risk. I may be bearish, but I'm not (that) boring.

A Risk-Seeking Bear

So while I will carp about valuations, bubbles, ponzi schemes, and the other, ever present market craziness, know that these bearish views do not make me a shrinking violet. I am risk-averse but not risk-less.

The first priority in any risk-based venture, whether a stunt performance or small cap investing, is survival. A healthy risk aversion, with a focus on avoiding the downside, is the logical approach. Return should be evaluated and pursued only after there is a reasonable assurance of safety.