Portfolio risk control is critically important to our investment process. Our approach to risk management is to be aware that risk other than stock specific risk can be diversified away. We classify risk into three main categories—stock specific, common factor, and market risk—and utilize several tools to actively manage each source of portfolio volatility. Our objective is to position all portfolios so as to realize the highest risk adjusted premium the market will bear.
We use information about excess return volatility to evaluate portfolio risk, to decompose portfolio risk according to common factor exposures, and to evaluate how much of a portfolio’s excess return in a given period was due to each common factor exposure and how much was due to stock selection. We closely monitor and control the total risk of the portfolio as well as the tracking error to its benchmark. Marginal contribution to portfolio risk by security, industry, and sector are other measures of risk that we use.