In an insightful book “Distress Investing”, the author, legendary investor, Martin J Whitman writes on how outside passive minority investors (OPMIs) can alleviate investment risk.

“The methods by which OPMIs can attempt to alleviate investment risk are:

Ø       Buy cheap. Warren Buffett, the chairman of Berkshire Hathaway, describes his investment technique as trying to buy good companies at reasonable prices. Buffett, however, is a control investor, and while a reasonable price standard has worked remarkably well for Berkshire Hathaway, that standard is not good enough for OPMIs. OMPIs have to try to buy at bargain prices (i.e., cheap). The definition of cheap in acquiring common stocks in the vast majority of cases is to acquire issues at prices that reflect substantial discounts from readily ascertainable net asset values (NAVs), and such NAV is likely to increase by not less than 10 percent per year. Readily ascertainable NAVs means that most OPMI common stock portfolios will to a large extent be concentrated in financial institutions and companies involved with income-producing real estate. Control investors can afford to pay up versus OPMIs, because they are in a position to undertake financial engineering and to cause management changes. OPMIs pretty much have to leave companies as-is, and therefore place particular efforts into buying into well-managed businesses with stable, but clearly superior, managements. In investing in distressed debt, too, the OPMI investor has to buy cheap. For the authors there are two rules of thumb in 2008: If the analysis indicates the probabilities are that a loan will be a performing loan, the minimum return sought is a 25 percent yield to maturity or yield to an event. Coupled with this is the requirement that if the loan does not remain performing and participates in a reorganization, the loss to the investor should be minimal. If it seems likely that the performing loan will default, the distress investor participating in a reorganization ought to look for an internal rate of return (IRR) well north of 30 percent.

Ø       Buy equity interests only in high-quality businesses or well-positioned debt instruments. One reasonable rule for OPMIs is to not knowingly acquire the common stock of any company unless that company enjoys a superstrong financial position. If a company does not enjoy strong finances, be a creditor owning well-covenanted debt instruments. Also try as an OPMI to buy into reasonably well-managed companies. Any relationships between OPMIs and corporate managements combine communities of interests and conflicts of interest. Diligent OPMIs try to restrict themselves to situations where the communities of interest seem to outweigh the conflicts of interest. Restrict common stock investments to companies whose businesses are understandable to the portfolio manager and where there exists full documentary disclosure, including audited financial statements. In distress investing, the creditor has only contract rights. These contract rights ought to be strong enough to preclude or at least discourage management overreaching.

Ø       Ignore market risk. Fluctuations in market prices are mostly a random walk, with changes in market prices not in any way a measure of long-term investment risk or investment potential. It is as Benjamin Graham used to say: "In the short run the market is a voting machine. In the long run the market is a weighing machine." Most competent control investors-again Warren Buffett-pretty much ignore market risk also, in that little or no weight is given to daily, or even annual, marking to market for portfolio holdings.

Ø       If dealing in equities, buy growth but don't pay for it. In the financial community, growth is a misused word. Most market participants do not mean growth, but rather mean generally recognized growth. Insofar as growth receives general recognition, a market participant has to pay up. Cheung Kong Holdings, Forest City Enterprises, Covanta, and Toyota Industries Corporation are growth companies. None of these issues seemed to enjoy general recognition as having growth potential in the fall of 2008.

Ø       It is usually a good idea to be a buy-and-hold investor. Although an entry point into a common stock is a bargain price, one can continue to hold a security where the portfolio manager believes that the business has reasonable prospects that it can over the long run increase annual NAV by a double-digit number, and where the portfolio manager does not believe he or she made a mistake. Mistakes are measured by beliefs that there has occurred a permanent impairment in underlying value or financial position. Sell if there is a belief that the security is grossly overpriced. Also sell for portfolio considerations-that is, where there are massive enough redemptions of funds under management so that liquidity is threatened. Most sales in most well-run portfolios will occur because the portfolio companies are taken over. Investing in distressed credits, however, involves having some idea of a termination date. If a loan is to remain a performing loan, the instrument will contain payment schedules and a maturity date. If the distressed credit is to participate in a reorganization, there will be an estimated reorganization date; and if the debtor is to be liquidated, there will be an estimated payment date.”