One of the more popular marketing ploys in investing these days is to claim “superior risk management”. It seems every manager and every strategy today highlights that they are supremely focused on risk, implying either that they are better at managing this hard-to-define term than everyone else or that they somehow avoid it, delivering returns without the commensurate level of risk to which others are exposed. It’s all rubbish.
Risk, simply put , is uncertainty about the future. No one person or entity is better at predicting the future than another. Furthermore, we all have access to the same historical data on volatility and other backward looking ways to measure “risk.” But there really is no such thing as “risk management”, at least not in the way investment firms imply – how does one manage that which we do not know and cannot predict? All we can do is be completely transparent about the risks to which we have exposure, how we are diversifying it across a portfolio, and what action we might take in the case of extreme events.
Cherry picking examples of risk management gone wrong is unfairly easy these days, but I can’t pass up mentioning the most obvious example…JP Morgan. This is a firm hailed as the premier risk manager in its industry, if not among all large companies, with CEO Jamie Dimon at its helm. Yet here we are, wondering how a firm so great at risk management could allow itself to take a $2-5 billion loss within a division of the firm whose sole mandate was limiting overall firm risk?! It’s just too perfect a story!
The discussion about risk needs to fundamentally change. Investing is, at its core, about taking on risk. Risk and return are inextricably linked and over long periods the data show that there is a very deliberate connection between the two. If one wants more return, one needs to take more risk…period. So rather than being fed a line about “risk management” from a firm’s sales person or better yet, from an analyst or portfolio manager (good luck getting to talk with one), ask about risk transparency and try to find out if they even understand the kinds of risk to which they are exposing their clients.
On an individual level, embrace risk to the degree you can and should. Risk shouldn’t be treated like a traditional a four-letter-word. Risk is the key to greater returns and if one has the right perspective toward it, greater returns are achievable with a lower level of anxiety. On the other hand, searching for managers who make claims that they can do the impossible and offer investors outsized returns for less risk is actually the riskier strategy. Those investors are more likely to get a worse risk/reward experience as they find they have bought a sales pitch that was always unrealistic, likely paying a premium for it in these exceptionally uncertain times.