In 2009, Geoff Colvin, an award-winning author and business writer for Fortune magazine, published a book titled The Upside of the Downturn. His chapter on risk was particularly enlightening and probably just as applicable to what’s going on today as it was to what was going on then, in the wake of the global financial crisis.
Six months before the events that triggered the beginning of that global financial crisis, a firm called Protiviti published its 2007 annual Risk Barometer. The report surveyed 150 top-level executives from large U.S. companies about their attitudes regarding risk. It asked, “How effectively does your company identify and manage all potentially significant risks?”
Colvin points out that the responses from nearly all industries were appropriately humble apart from two. You guessed it: financial services and real estate. In fact, 72 percent of the respondents from the financial services and real estate industries gave themselves the highest possible score on this measure.
These same executives also were asked to rate themselves and their companies on their “risk appetite.” Here, the financial services and real estate executives rated themselves much lower on the scale, suggesting they believed they had a lower-than-average appetite for taking on risk. Of course, it was these same executives’ inability to correctly assess their understanding of the risks they had assumed and their own inherent appetite for risk that brought the entire system tumbling down a few short months later.
My guess is, if that same survey were conducted today, the responses from the financial services and real estate executives wouldn’t be much different. Most of us in this business tend to think the one thing we’re really good at is assessing and taking on risk. And most of us delude ourselves into believing we’re quite risk averse. The unraveling that is taking place in the commercial real estate markets is a clear reflection of the old saw that “the more things change, the more they remain the same.”
Since the global financial crisis, many firms have created the position of chief risk officer. This only offloads the responsibility of senior executives and the board onto the shoulders of a patsy who will take the blame the next time things blow up. The same goes for all those risk committees many boards have set up.
In the investment world, risk taking is a fact of life. And thinking about risk is hard work, as Colvin points out. The hardest thing for anyone to do is to consider and think about the risk you never even imagined. “When executives received that 2007 risk survey described earlier,” notes Colvin in the book, “the greatest danger they faced — a global financial system meltdown — wasn’t even offered as one of the choices.” Yet, notes Colvin, plenty of pundits were pointing out the inherent risks embedded in that system. It’s not that no one was told what might happen; it’s that no one wanted to think about what might happen. But, as I’ve noted many times in the past, when you’re flying in an airplane loaded with too much booze and food and not enough fuel, the good feelings are only going to continue for a while.
Many of your firms also employ professional researchers to help you underwrite property markets, identify opportunities and, ostensibly, help underwrite risk. Most of these are pretty good at underwriting markets — if they’re listened to. And most are pretty good at underwriting property-specific risks and pricing — again, if they’re listened to. But where they often fail is in calling turns in the market.
Nassim Nicholas Taleb, renowned author of The Black Swan, likes to point out that to deal with ever-changing uncertainties, our minds build up narratives to explain what is happening around us. When those narratives lead us to experience some victories, we celebrate our own brilliance. When they lead to disaster, we blame fate or the gods or blind luck. There is hope here, however. You can train yourself to get better at understanding and taking risks. But this is never easy. You’re going to constantly be tempted to slip back into your heuristic ways of thinking and jump to cause when you’re really dealing with fairly random events. So, how do we escape this trap? Design practices to slow down the process of risk-oriented decision making, to make sure you’re not falling victim to one of the many mental traps that undermine our abilities to effectively manage risk.
If you’re an investment professional, the well-being of millions of people rests on your ability to make the right decisions every day with respect to risk. If there is any skill that’s critical to investment success, it is the ability to properly assess and choose the right kinds of risks. So, if you’re looking for an area for your own professional growth, I can’t think of a more appropriate one to pursue.
Of course, in doing so, it’s important to be careful. Be very careful. It’s a wacky world out there.
Geoffrey Dohrmann is president and CEO, publisher and editor-in-chief of Institutional Real Estate Inc.