Morningstar Advisor - April/May 2013 - (Page 55)
It is multifaceted. We take all of these into
account, at an individual security level
all the way up to the assets and firms that
we’re dealing with, and then ultimately to
measuring risk in various forms in the portfolio
context. It’s important to look at risk
measures beyond just volatility, although
volatility is important, and as always is the
case, trading off risk versus return. We go
through different states of the world and view
the portfolio at a horizon that would be
consistent with what we would believe is the
investor’s objective.
Accounting for the Unknown
Ratner: How do you incorporate the idea of
uncertainty into your processes? By that, I’m
using it in the Knightian sense of some event
that may fall entirely outside of the probability
distribution. The unknown unknowns.
Davis: The first part is very important. Human
nature makes it tough for us to realize that
no one can fully appreciate what can happen.
We do know what may have happened
in the past, but the actual outcomes could have
been potentially wider and of different forms.
That inherently has an impact on even the
historical performance of asset classes in the
economy, which form the basis of some risk
management tools and software. So, I think
that, in and of itself, is important to recognize.
Incorporating uncertainty is trying to think
through various states of the world; to put a
high primacy on the fact that we will
always have incomplete information, and to
treat the future with the humility it deserves.
When one has that at the forefront of one’s
mind in a portfolio construction and investment
management context, it becomes a default
mindset. We’re going to really put primacy
on risk and diversification as best we can think
through this process. But it starts first with a
mindset and an acknowledgement that we will
always have incomplete information, and to put
that at the forefront in one’s decision-making.
Stattman: There was a very important word in
there that I want to pick up on, and that’s
humility. As people survive in this business,
they survive by not letting their clients
down. Everyone, even the best investment
managers, makes mistakes, and plenty of them.
The key to survival is to limit the negative
impact of those mistakes. And the process of
surviving in a variety of investment
environments is one that teaches a great deal
of humility.
One thing that becomes clear through this
process is we know that we don’t know. There
are simply things that will happen in the
future that we have no idea of—9/11, for
example. Now, we could have imagined that
terrorists would do something big and
heinous. We could have imagined New York
City as a target. We might have even imagined,
since it was the second go-around, the
World Trade Center as the target. But we could
not have imagined the exact details or timing.
And that was an important shock to the market.
It was not knowable.
There will be other areas where we apply our
research and judgment and see that there’s risk.
It was very clear to our team that there
was a tremendous amount of risk building up in
the financial sector around mortgages and
big risk-taking on the part of lenders who were
aggressively pursuing low-quality loans.
where humility comes in and helps us
not push the envelope too far on risk-taking
under the false assumption that we know more
than we can know.
Ratner: Great, thank you for this discussion. I’d
like to ask each of you for a final word to wrap
up any additional thoughts you may have.
Stattman: Well, I’m just going to circle back
to what I said at the outset, which is, ultimately, risk has to be judged within the context
of meeting client objectives and expectations.
Second, we should never, ever lose sight
of one particular idea about risk, and that is the
idea of risk as the chance of permanent loss
of capital.
Davis: If we put our clients’ interests and their
objectives first, and we always keep that
at the forefront of our minds, then we as
investment management firms and as investors
will always be well-served. We need to
acknowledge that we will never have complete
information on the markets. That comes
back to many time-tested and timeless
investment principles: balance, diversification,
and a long-term orientation. K
Hal Ratner is the chief investment officer, Europe,
with the Morningstar Investment Management division.
And despite this, we couldn’t know with any
exactitude the timing of the peak in housing
prices, the exact nature of which banks
and financial institutions would suffer the very
most. We could look at who was leveraged and
who was exposed to the mortgage side,
but there was not sufficient transparency to
know exactly how bad these outcomes could
be for particular institutions.
So, even in situations where we see a sector
that has outsized risk potential, even if
it’s not realized now, understanding the exact
manifestations of how that risk will be
actualized is impossible for anyone. That’s
MorningstarAdvisor.com 55
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Table of Contents for the Digital Edition of Morningstar Advisor - April/May 2013
Morningstar Advisor - April/May 2013
Contents
Contributors
Letter From the Editor
The Pursuit of Happiness and Financial Advice
What Strategies Do You Use to Control Risk?
Driven to Succeed for Clients and Family
How to Assess a Portfolio’s Bond Risk
Luck, Skill, and Investing
Investments á la Carte
Investment Briefs
Investing’s No- Brainers Have Costs
A Defensive Ride
Risk On/On Risk
The Risk of Being Overconfident
Year of Living Dangerously
The Risk-Parity Approach
A Guide to Mutual Funds Running Risk-Parity Strategies
What Moats Tell Us About Risk
Risk’s Wake-Up Call
Seeing Is Believing
Why Investors Lag the Returns of Their Funds
Liquidity Signals
Pump Them Up
Golden Oldies Keep on Truckin’
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Our Social Blind Spot
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