3 things investors can learn about risk from the U.S. Army
Major Hugh Jones is a professor of finance and economics at the United States Military Academy and has had two tours of duty in Iraq. He also has an MBA from Duke. He spoke last year at the CARE conference (Center for Accounting Research and Education conference) about how the U.S. Army deals with high-stakes risk. The video below is his presentation at CARE (thanks to Professor Darren Roulstone for bubbling up his speech!). You can get slides of Major Jones' presentation here [.pdf]. Here's what investors can learn from how the U.S. Army deals with risk.
The US Army's Risk Mitigation programDefining risk The U.S. Army separates the definition of risk from uncertainty (like we did in last week's post on defining investment risk).
- Risk: known hazards (things we can identify that can cause harm)
- Uncertainty: unknown hazards (anything unpredictable and ambiguous that can arise from complex systems.)
The Army has a feedback loop to handle managing its risks that involved an unending process to identify all known hazards, assess them, and then develop tools and procedures to control for these pitfalls.
Putting risk management into practice
The army uses two types of solutions to manage risk and uncertainty:
- information-based solutions: collect more and better data
- for this to work, need superior information
- need a system to disseminate right info to the right person, continuously pushing and pulling information
- facilitates collaborative planning
- Needs massive storage to house all virtual and physical infromation
- action-focused solutions: building risk-management organizations
What investors can learn from the armySo, what's the point here? Here's what investors can take away from how the Army manages risk and uncertainty.
- need different types of solutions: investors need a plan of action that proactively deals with risk but simultaneously, continues to assess the information landscape out there, updating with new known information. Investor frequently suffer from paralysis from analysis -- there's just too much info 24/7. So we need action, too.
- admit that we can't know everything: the Army's action plan -- at its core -- admits it needs to move forward without understanding every eventuality. That's OK -- and it's developed a proactive chain of command to help all its participants to make the best decisions they can, when they can.
- red teams = investment teams: I like the concept of specific teams to help bubble up fresh, contrarian ideas to challenge the status quo thinking. Having people whose responsibility it is to broaden everyone's understanding is super valuable. It's like an internal consultant and oversight body, yet challenges groupthink.
Whether you're an individual investor managing your IRA or a portfolio manager running billions of dollars, you need a system to manage risk.
That's your fiscal responsibility -- just setting and forgetting your investments is a ploy by the financial industry to get you out of the game. You can continuously monitor things without making daily/weekly/monthly changes to your portfolio. But you should have a system.
Entering an era of risk-aware portfolios
Look at all the investors who got caught with their pants down when the markets tanked in 2008. I think we're going to be entering a new era of risk-aware portfolio management. Where investors use some quantitative or timing mechanism (Tactical Asset Allocation) to help them deal with risk. The tools and research are being developed as we speak.
We just need a real plan to deal with investment risk. It's time we stop BS'ing and act more responsibly.
What are your takeaways from this presentation?