Risk Perception/Risk Assessment/Risk Management.

“But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade? And how do we factor that assessment into monetary policy?”

Alan Greenspan, 1996

“If anything kills over 10 million people in the next few decades, it’s most likely to be a highly infectious virus rather than a war,” Gates said. “Not missiles, but microbes.”

Bill Gates, 2015

Risks usually don’t get picked or play-out just because somebody has the vision to see it.

A “Risk” is not a risk if it can be anticipated.

That’s true because then you have the opportunity to plan for it.

For example, if you go on a jungle safari, you anticipate wild animals and hence you have a guide/expert taking you through the safari with enough safeguards to protect you.

It is a “Risk” when either you cannot anticipate, or once anticipated, don’t plan for it, ignore it or even under-play the risk.

Let me give an example:

The rising complexities of the markets, which spawned more and more complicated instruments like credit-default swaps and mortgage-backed securities, had in fact made the global financial system a much riskier place, not less so as many believed.
Raghuram Rajan, 2005 Jackson Hole

“the basic, slightly lead-eyed premise of [Rajan’s] paper is misguided”.

Larry Summers, Former US Treasury Secretary on Raghuram Rajan Jackson Hole speech

Where is my TAIL?

The tail risks is usually a rare event.

Probability of a rare event is low but impact is very high.

Usually in good times, liquidity sloshing around, asset prices inflating, portfolios making you feel good can make even the most obvious risks appear irrelevant.

Often investors in a bull market wonder about risk and then themselves discount it citing exuberant environment.

However a tail risk is like steam pressure building up in the cooker, you know it is going to be enough at some point for the cooker to give you the whistle.

That whistle is your warning, however mental exuberance makes people continue to build on the risks.

What should an investor do?

  1. Have an “objective” with a timeline?
  2. Have a thesis on which asset class and within that asset class which particular asset will you choose and why;
  3. Choose quality of investment over returns, basically don’t get driven by speculative reasons or short-term outcomes to make investing decisions
  4. Quality businesses with healthy balance sheets survive crisis and emerge stronger as the pandemic has shown us and hence choose quality over businesses over any other proposition
  5. Patience-not only after but even before investing-Get your price right in a quality business and enjoy the journey
  6. Remember you are not responsible for an NAV but your goals.
  7. Investing finally is not entertainment nor is it show business.
  8. The biggest show-off can be when you achieve your goals and that day you will not have to show-off, everyone will see it for themselves

Finally “Stay the course”

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