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Value Investing and Enterprise Risk Management: Two Sides of the Same Coin

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Value Investing and Enterprise Risk Management: Two Sides of the Same Coin Value Investing and Enterprise Risk Management: Two Sides of the Same Coin Sponsored by Society of Actuaries’ Committee on Knowledge Extension Research Prepared By Max J. Rudolph Rudolph Financial Consulting, LLC January 2013 © 2013 Society of Actuaries, All Rights Reserved The opinions expressed and conclusions reached by the author are his own and do not represent any official position or opinion of the Society of Actuaries or its members. The Society of Actuaries makes no representation or warranty to the accuracy of the information. Contents Executive Summary ............................................................................................................ 5 Risk and Return – A Balancing Act ........................................................................................................ 5 Unique Solutions ................................................................................................................................... 5 Background ......................................................................................................................... 7 Researcher ........................................................................................................................... 7 Introduction ......................................................................................................................... 8 Fundamental Analysis ........................................................................................................................... 8 Mosaic Theory/Scuttlebutt ................................................................................................................... 9 Buffett’s Search ................................................................................................................................... 10 Structure ............................................................................................................................................. 12 1- Introduction ........................................................................................................................................ 13 ERM ..................................................................................................................................................... 13 Value Investing .................................................................................................................................... 15 Comparison - Introduction .................................................................................................................. 16 2-Governance and an Enterprise Risk Management Framework ........................................................... 16 ERM ..................................................................................................................................................... 16 Value Investing .................................................................................................................................... 19 Comparison – Governance and an Enterprise Risk Management Framework ................................... 21 3-Risk Management Policy ...................................................................................................................... 22 ERM ..................................................................................................................................................... 22 Value Investing .................................................................................................................................... 24 Comparison – Risk Management Policy .............................................................................................. 28 4-Risk Tolerance Statement .................................................................................................................... 29 ERM ..................................................................................................................................................... 29 ©2013 Society of Actuaries, All Rights Reserved Rudolph Financial Consulting LLC Page 2 Value Investing .................................................................................................................................... 29 Comparison – Risk Tolerance Statement ............................................................................................ 35 5-Risk Responsiveness and Feedback Loop ............................................................................................ 37 ERM ..................................................................................................................................................... 37 Value Investing .................................................................................................................................... 38 Comparison – Risk Responsiveness and Feedback Loop .................................................................... 40 6-Own Risk and Solvency Assessment (ORSA) ........................................................................................ 42 ERM ..................................................................................................................................................... 42 Value Investing .................................................................................................................................... 43 Comparison – Own Risk and Solvency Assessment (ORSA) ................................................................ 45 7-Economic and Supervisory Capital....................................................................................................... 47 ERM ..................................................................................................................................................... 47 Value Investing .................................................................................................................................... 49 Comparison – Economic and Supervisory Capital ............................................................................... 49 8-Continuity Analysis .............................................................................................................................. 50 ERM ..................................................................................................................................................... 50 Value Investing .................................................................................................................................... 51 Comparison – Continuity Analysis ...................................................................................................... 52 9-Role of Supervision in Risk Management ............................................................................................ 53 ERM ..................................................................................................................................................... 53 Value Investing .................................................................................................................................... 53 Comparison – Role of Supervision in Risk Management .................................................................... 54 Conclusion ........................................................................................................................ 54 Appendix I - Howard Marks ............................................................................................ 56 Appendix II - Phil Fisher: The 15 points to look for in a common stock ......................... 60 Appendix III - John Train’s winning investment strategies ............................................. 61 ©2013 Society of Actuaries, All Rights Reserved Rudolph Financial Consulting LLC Page 3 Appendix IV - An Investing Principles Checklist ............................................................ 62 Appendix V - Tenets of the Warren Buffett Way ............................................................. 64 Appendix VI - Investing for Insurers ................................................................................ 65 Appendix VII - How Warren Buffett is Different from Most Investors ........................... 66 ©2013 Society of Actuaries, All Rights Reserved Rudolph Financial Consulting LLC Page 4 Executive Summary “Investing is simple, but not easy.” Warren Buffett “Everything that can be counted does not necessarily count; everything that counts cannot necessarily be counted.” Albert Einstein Risk and Return – A Balancing Act The goal of this paper is to examine similarities between value investing and enterprise risk management (ERM) methods. For some, especially portfolio managers, this may be obvious. These investors come to the table with experience using risk as a constraint while trying to optimize returns. Years of experience have taught this group that risk balances return, and that return balances risk. Value is added by creating favorable imbalances. The investor with high returns and average risk has succeeded, as has the investor reporting average returns and low risk. Many concepts are shared between ERM and value investing. When defining risk, which is generally unique to the individual, an analyst considers uncertainty, downside risk, and optimization. Value investors look at concepts like conservative assumptions, margin of safety, and asset allocation. These concepts are comparable, and this paper uses the International Actuarial Association’s Note on enterprise risk management (ERM) for capital and
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