PERFORMANCE ANNOUNCEMENT

As Of: September 13, 2004

INVESTMENT RISK

Risk management separates the true professional

      The neighborhood gas station where I usually purchase my gas also sells lottery tickets. I am constantly amazed (and sometimes irritated) at the line of people waiting at the counter to purchase lottery tickets. I am simply baffled by people who will engage in an activity where the odds are so staggeringly weighted against them. Some of these people look like they barely have enough money to feed and clothe themselves, yet I have to believe that on some level they know they are going to lose all the money they spend on lottery tickets. And in the face of that knowledge, they must believe that they can afford to lose that money.

      This brings into question the subject of risk management. Every investor needs to take some risk in order to expect to gain a return greater than the "guaranteed" rate of U.S. Treasuries. Risk management involves weighing the risk of receiving a lower return (or of losing one's capital) against the expected reward from an investment. But, like the lottery player, risk management also involves weighing how much of one's assets can (or should) be risked at any level. Classic tales have been written about "the sure thing", in which family fortunes have been wagered on a venture that had an infinitesimally small risk of loss; but sure enough, that one-in-ten-million failure turned out to be the result.

      Thus, risk management has two components: 1) Not risking more than you can afford to lose, and 2) accurately assessing the risk in relation to the potential reward. Addicted gamblers usually fail on both counts. They take wildly unrealistic risks, and they play with money they cannot afford to lose. Investors tend to use diversification to mitigate the risk of a total wipe out. More sophisticated investors also use long-short hedging, options, and other derivatives to control their risks. There is no easy solution for the problem that many investors still have assessing an appropriate level of risk in relationship to the expected reward (return on investment). There is no simple formula. I believe there is really no substitute for experience and diligent research. This is probably one of the greatest advantages that a professional has over the "amateur" or part-time investor.

      In my mind, a professional is not some young kid who has a license because he passed a written exam. A professional is someone who has invested his own and other people's money over a long period of time across many different markets and through many different economic cycles. For example, a true professional should have survived the tech wreck in 2000 without any real damage. The markets have a remarkable ability to separate the inexperienced from their money. While most investors focus on trying to pick the biggest winner, the most successful are also managing their risk. A true professional is someone who has a track record as a survivor.

      When deciding whether to "do it yourself" or obtain the help of a professional, risk management is one of the important factors that should be considered.