Of Black Swans and Grey Rhinos

Aesop’s fables that came to us via the oral rather than the written route was about allegories and humor with a moral lesson.

Take for example the story of the Eagle and the fox who made a pact to live in peace.

The eagle had a nest on a tree, and the fox made its home in the bushes near the tree. The fox had baby foxes and then went hunting. The eagle came and took the baby foxes and gave them to his children.

The fox was sad about it but did not know how to get her revenge. Afterward, the eagle stole a piece of meat from the shepherds while they were cooking it. Eagle wasn’t careful enough, and he brought some ember with the meat. The nest caught fire, and the little eagles fell out of it.

The fox came and ate them all. She got her revenge by accident.

The first part of the fable is the storytelling part and the second one carries the moral of the story. The lesson is that everyone who lets down a friend will pay for it.

It’s not a Black Swan, it’s a Grey Rhino

Fox believed that she and the eagle could be friends. He let her down which was expected. She was sad when he ate the little foxes but mostly, she was sad because she couldn’t get her revenge. At the end, we see that she is revengeful because she couldn’t wait to pay the eagle back for what he has done.

“He let her down which was expected”.

That’s the key, risk was there.

Trust replaced the risk and lulled the fox into false sense of safety, and it didn’t play out.

Black Swan is usually an event with low probability of happening and hence takes you by surprise.

On the other hand, Grey Rhino is an expected risk and that’s why gets discounted, and people don’t plan for it.

Grey Rhinos can become black Swans

Behind every supposed black swan is a “crash” of grey rhinos (“crash” is the zoologically correct term for more than one rhino). You had several potential dangers in 2007 and 2008, and many people sounded the alarm. The black swan emerged when all these obvious dangers interacted, creating a problem much bigger than any one of them. That’s very hard to predict. It’s very hard to tell where it’s going to go — and how big it’s going to be. With grey rhinos, it’s generally a case not of if but when. If they all blow up at the same time, that is your black swan.

You’ve a choice to do something about it or not. It’s a metaphor for the fact that so many of the things that go wrong in business, in policy, and in our personal lives are actually avoidable.

We don’t pay enough attention to the big obvious problems that are in front of us. By regularly doing a grey rhino reality check, you can be way ahead of your competitors and your peers.

What Should you Do?

Ask yourself some simple questions:

  • What is my grey rhino?
  • What’s the big thing in front of me that’s going to trample me unless I do something?
  • How good a job am I doing in dealing with it?
  • Have I properly accounted for the cost of not dealing with it?
  • How much power do I have to change it?
  • If I have the power to do something, then what’s my goal?
  • Is it just getting out of the way?
  • Is it to turn the challenge into an opportunity?
  • If I don’t have the power to do something, then who does have the power? What can I do to get them to change the situation?

Investor’s Dilemma?

The 1st instinct of every investor is of-course fear.

And there is always something to fear.

The question is not just about the fear but what’s your strategy to face it?

Markets on an average correct 15-16% every year and that’s feature not a bug in investing.

If you can’t take that risk, you shouldn’t be in the market

Peter Lynch (legendary Fidelity Manager) in his book-A walk down wall street taught us how to identify a good business and then wait for market imperfections to buy them at the fair price.

These annual corrections that might/might not happen for a reason are your opportunities to create value for your portfolio.

Embrace them instead of fearing them

In-fact by identifying “grey rhinos” that can have an impact on the market, you can have your dry powder ready to take advantage of them.

End of the day, equity investing is about “risk-profile”.

Take as much risk as your risk-profile dictates so you can sleep well at night and then long-term compounding do its magic.

This is not a short-term game and “grey rhinos” help you increase your ability to take advantage of the short-term anomalies.

Happy investing

Follow my twitter handle @manver1974 for more such shares

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