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September 01, 2009 at 04:00 AM
What happens when the hunter confuses the shadow for the prey? Well, you miss the shot and you go hungry or worse.
What happens if your clients buy into the wrong investment ideas, chase the high performers of yesterday instead of finding the future performers of tomorrow, buy high and sell low? Well, they do not get the returns they expect and ….
“Here Be Dragons” is a caption often seen on old maps. Have you ever seen unretouched pictures of the planets in our solar system? The dark side always seems so large. Remember, you need a source of light to see something. A single source of light will create a large shadow. In our solar system, there is a single source of light that dominates all others. You don’t need to remember Pink Floyd’s lyrics to fear the dark side of the moon.
I worked for a few years in a large corporation with a proud name and long history where the managerial mantra was “Perception is Reality.” There was only one source of light and it shone so strongly through the political prism of the institution that it overcame people’s sense of reality. Perception became reality!
However, reality is reality. Soon enough, others saw the corporation for what it was. A more “perceptive” institution bought it out and the old, proud name is now gone. Not all may be lost; I think I still have the corporate tie and perhaps even a bowtie with its beautiful logo.
We need multiple sources of light to cancel the importance of their respective shadows. We need multiple types of analysis to see what dwells on the “dark side” of the markets. However, our sources of investment light have become so single-threaded that it is hard to distinguish the shadow from the prey. Recent events remind us all that these shadows have become large enough to hide dragons.
In an excellent article in the May/June 2009 issue of the Financial Analysts Journal, “A Simple Theory of the Financial Crisis; or, Why Fischer Black Still Matters,” economist Tyler Cowen points out the errors of expectations that individuals, entrepreneurs, investors and even entire societies develop when they feel wealthy. The article is helpful because it moves us away from narrow, “root cause” explanations and instead forces us to see the generalized, worldwide conditions that led us to where we are.
Since the 1980s, we have lived through a period of exceptional and worldwide wealth creation. This generalized feeling of wealth led many of us to over-invest in risky assets in the hope of greater returns. The insight “take more risk to achieve more returns” shone so brightly that we failed to see what lurked in the shadows: taking more risks also raises the odds of collapse.
Seeing Things Anew
Now that the possibility of individual, institutional, sectoral and even societal collapse has appeared, we need to create and maintain multiple sources of investment light, or one source will dominate all others and warp our sense of reality. So, what are the new investment insights, the new sources of light and understanding that we can use to peer into the dark side of portfolios?
To help answer this question, the Retirement Income Industry Association supports three major approaches to shed light on the reality of retirement income portfolios.
