Tuesday, December 2, 2014

Risk management - learning beyond your limits

"It's what you learn after you know it all that counts."
-JohnWooden 

Some of the best words to hear from a risk manager is "I don't know all of our risks."

The key principle from the Black Swam risk management movement is that even if we measure all of the risks from all of the data available there are still risks that may not been measured. Our data may not include events that have not occurred before. Our assumptions of what may go wrong in stress test may not include the truly unexpected. We can know it all, but will still have more to learn about what could have a negative impact on a portfolio.

These hidden or unknown risks suggest that a precautionary view needs to be used whenever building portfolio. Make sure that any unknown or hidden event will not take down the performance of the portfolio. Over diversification should be avoided, but excessive concentration even when you "know" all of the risks is not prudent. There will always be more to learn and the expense should not come in the form of a debilitating unexpected event. 



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