Risk Management

Position sizing

Securities in the Opportunity Strategy are primarily chosen for their upside potential, but sized according to downside risk.

To us, risk does not equal “beta,” a numerical measure of stock volatility often used in business schools and other firms. Rather, we view risk as the potential for permanent capital loss.

To gauge this risk, we analyze the fundamental factors pertaining to the economics of the business in question, including:

  1. Management Integrity (and skill)
  2. Balance sheet
  3. Strength of competitive advantage
  4. Number/diversification of products/ business segments
  5. Industry outlook/ secular trends
  6. Volatility of demand and/or supply
  7. Our conviction/ familiarity with the company and industry

Our fundamental approach to risk is a defining characteristic of the Opportunity strategy.

Flexibility and Limits

While long U.S. equity is our primary strategy, we ask clients for the flexibility to:

  1. Invest across all-capitalizations
  2. Purchase non-U.S. securities
  3. Use options in moderation, and on an opportunistic basis, to generate income and hedge risk
  4. Short individual stocks or indices, within limits
  5. Purchase fixed income securities (likely distressed situations or in times of high interest rates)

However, we impose certain limits (subject to change with investor approval):

  1. Position size limit of 25% at cost (40% absolute) – though positions this size are rare
  2. 25% limit on non-U.S. securities (due to currency risk)
  3. 25% limit on short positions (due to unlimited downside risk)
  4. Our base case is to use no leverage, with exceptions in small amounts relative to overall equity, and on a temporary basis, for timing trades in equities and options.

Market Risk

Stone Oak Capital considers itself a bottom-up investor and not a market-timer, yet does monitor general market conditions for systemic risks and adjusts the core strategy accordingly. In general, the Opportunity Strategy leans towards being fully-invested, but will go to cash or use short positions/hedges in certain circumstances where we feel market risk is elevated.