How do you reduce risk?
Portfolio managers view risk very differently. Some managers discuss conscious efforts to make sure they are diversified, so they are not overly concentrated within a particular industry, which can happen when using any screening process.
Conversely, other managers consider overweighting or underweighting certain industries to be a risk-reduction method—they stay out of the "riskier" areas.
Sector fund managers tend to discuss the various market segments within the industry, and which companies are riskier. They may try to limit their exposure to those areas.
Interestingly—and perhaps this is not too surprising—some portfolio managers consider their stock picks to be risk reduction.
You may disagree with whether these measures actually lower risk, but you do need to know about them if you are going to invest in the fund.
What would prompt you to sell a stock?
This is a key question that reveals much more than you may think.
Every portfolio manager will have his own specific reasons for selling stocks. For instance, one fund manager invests in small emerging growth companies, but sells his holdings if they are taken over, when they have reached a stage where they need a different type of management. Another sells his "value" stocks when valuations get too high relative to the market, or relative to other potentially undervalued stocks.
However, there is a common thread among all of the reasons that tend to be given by portfolio managers who follow a consistent and well-thought-out investment approach, and that is that a stock will be sold whenever it no longer meets the manager's investment criteria.
It may no longer meet that criteria because it has done what the manager wanted—it's gone up in price-and he feels that it has gone up about as far as his approach is capable of judging it.
Or, the stock may no longer meet his criteria because somehow the company has fundamentally changed or the portfolio manager realizes he or she made a mistake and the stock never really met his criteria in the first place, or another stock better meets the manager's investment criteria. But the stock is always judged on its own current investment merits relative to the manager's investment criteria; share price alone is almost never mentioned, and price drops are frequently viewed as buying opportunities, particularly if due to an overall market move.
The point is, in order to sell a stock, a consistent portfolio manager must have a pretty clear idea of why he or she bought the stock in the first place. So the answer to this question gets to the heart of a portfolio manager's investment approach, and the answer needs to be consistent with the manager's overall investment philosophy and selection criteria.
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