Buffet 2014 on risk management

“Though practically all days are relatively uneventful, tomorrow is always uncertain. (I felt no special apprehension on December 6, 1941 or September 10, 2001.)”

- Warren Buffet 2014 annual report

Great simple quote on the fact that we have to always be set for surprises. What is a good environment today may change radically tomorrow. We can and will be surprised. A large amount of risks occur when the markets are closed for a given region. The close to open risk can be as large or larger than the behavior from open to close.

However, this does not mean that we should avoid taking risks. What it does mean is that making sure you are diversified at all times is the number one risk management solution. Ensure that on any day a surprise will not destroy your portfolio. 

I think one of the best risk approaches is through volatility management not position exposure management. Risk parity provides one of the best diversification solutions especially when the risk budget is divided across factors. A portfolio manager can allow for tilts in the risk budget but the null of equalization is a good starting place when there is no information advantage.