Everyone talked about how much riskier the investment climate was immediately following the global financial crisis. But was it really?
I’d argue the period of time leading up to the global financial crisis was a lot riskier than the period following it. Going into the global financial crisis, there were a lot more things that could go wrong and almost no one was paying any serious attention to them. Oh, there were plenty of voices crying out in the wilderness warning about the impending financial market meltdown. But most of these were treated as Cassandras, alarmists, party spoilers. Everyone was making too much money to attempt to pull in their oars and hunker down the ship until the storm blew over.
Once the markets collapsed, however, investors suddenly had much fewer options. That means there were far fewer things that could go wrong, and most of the things that could go wrong were now known. So, while everyone’s awareness of risk was elevated, the actual risks were fewer than prior to the collapse of the markets.
This is the way risk recognition and markets always tend to operate. Everyone starts to worry about securing the door only after the cows already have vacated the barn. The fact is most reactions to risk involve scraping the toast after the risks have turned into adverse events.
A more productive approach to risk management would be to identify in advance all the things that might burn the toast in the first place, and then taking preventative actions in advance to ensure those things don’t happen. (It’s always less time consuming and less wasteful to not burn the toast in the first place than it is to have to scrape the toast afterwards.)
Risk will always be with us, of course. Risk has been defined as the fact that more things can happen than will happen. Recognizing this fact forces us to start thinking about impact and probabilities. Which things that could happen would have the most adverse impacts on our short- and long-term investment success? And, of those, which ones are most probable, i.e., most likely to occur? And, of those that are most likely to occur, what if anything can be done to prevent them from occurring (or insulate our portfolio from those occurrences should they in fact occur)? And — especially for those highly impactful, highly improbable events that still could happen — what steps can we take to minimize the negative impacts, should those events in fact occur?
The Kepner-Tregoe organization of Princeton, N.J., has been training managers and decision-makers at Fortune 500 companies to ask these kinds of questions (what they call “rational processes”) for more than 60 years now. Hundreds of thousands of professionals have gone through these programs. While universally effective when applied, very few of their graduates actually end up continuing to practice the use of these processes after several months have passed from their graduating from these courses.
Why? Human nature, plain and simple. Most people simply aren’t willing to put in the hard sustained effort it takes to replace old heuristic habits (thinking fast) with new, more systematic approaches that take more time and feel more like hard work (thinking slow). So, most of us continue to stumble around blind to the true realities of risks that surround us. Now, in a prolonged bull market, most of these poor decisions are hidden by rising tides. It’s only when the party ends, when the tide rolls out, that we find ourselves standing naked on slippery ground.
The most important thing this industry can do is devote itself to mastering the art of risk assessment. Accomplishing this won’t be easy. The work you’re going to need to do to discipline your brain and build more productive thinking habits is going to be hard; it literally is going to be a painful process as the two hemispheres of your brain struggle for control. But the end product will be worth it.
Where do you start? The best place to start is at the top. The leaders of your firm need to prioritize becoming wiser about assessing risks and about taking risks. They need to invest in the training necessary to make good risk assessment skills and appropriate risk-taking behavior an integral part of your company’s culture. And they need to encourage you and your co-workers to develop better risk assessment and decision-making frameworks and tools.
But, even if they don’t, that doesn’t mean you personally can’t get better at dealing with risk. Doing so can only boost your career prospects. So, what are you waiting for?
Of course, it’s important in doing all this for you to be careful. Be very, 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., parent company to Real Assets Adviser.