By Jason A. Voss, CFA via Iris.xyz
In summary of my series so far on Real Risk Management, each of us subjectively has preferences. These preferences, coupled with our chosen contexts, are what creates risk. As an example, if I choose to “beat the market” I have a chosen context of financial markets, and a preference to beat the performance of that market. The risk I’ve created is that I under perform. This may sound elementary and straightforward, but this stands in starkest contrast to the variance, standard deviation, beta, covariance, VAR, et. al. versions of risk promulgated in modern finance. Throughout the series, lurking in the background are issues are temporality. That is, the effect of time on risk management. Let me redress that deficiency now.
There are multiple temporal (i.e. time-related) issues that we need to get right if we hope to engage in real risk management. To me, these are:
1. Facts (the past) are often at cross purposes with investing (the future).
2. Our choice of time horizon introduces additional preferences/risks in our investment outcomes.
Risks are Future-Oriented
Because risks are about the possibility of a failed preferred outcome, it also means that they are about the future. After all, we anticipate possible futures, evaluate those possible futures, and then choose which possible futures we care about/hope to have happen.
As I have been saying for years: there is no such thing as a future fact. Facts, by definition, occur in the past, yet investing and its results unfold in the unknowable future. Facts and investing are, in many ways, at cross purposes with one another.
Magnifying the effects of the cross purposes is a mistaken belief on the part of almost all research analysts and portfolio managers in their objectivity. Yet, as I have demonstrated in these articles, risks are created by our preferences for contexts and outcomes. So, why do we care about facts in investing?
Click here to read more on Iris.
