The myth of taking high risk to yield a higher return.


Director, Banyan Tree Advisors

December 18, 2011

Do you have to take high risk for high reward?

We are some times asked by some of our investors as to why we do not target a relatively higher rate of return by taking a little more risk. These queries flow from all the traditional investment text books where as per the Capital Asset Pricing Model, an investor is taught that if some one wants to achieve a higher rate of return one should opt for taking on more risk

The Holy Grail of the investing world is “Low Risk, High Rewards”.

Based on a thorough analysis of the best performing stocks over long period of time, not just in India but across several markets, we notice that there is common trait across many of the high performing stocks. These companies typically require very little capital to grow (fixed assets and more importantly very low working capital), have very little or no debt on their books, grow at a steady pace, are highly profitable and are run by high quality management. They are also among the most efficient within their industry, and the management is committed to managing their finances efficiently. A cursory glance at all these characteristics should tell you that these are the characteristics of companies which embody very low business and financial risk. These are not the high risk companies which load themselves up with a lot of debt, put up large projects and risk shareholders’ money.

We strongly believe there is an approach to investing in equities which is low on risk, but can lead to a more than satisfactory rate of return. We do not claim that we have found the Holy Grail, but we are fairly certain that the conventionally accepted linear Risk-Reward equation can be skewed in your favour.