Twenty Twenty

A lot of maths used for the management of risk is problematic. There is a desire to make it look pretty, and come up with models and numbers to give the illusion of understanding. If you can measure it, you can manage it, the theory goes. The real value in models is simply a device for thinking through something. A tool to help us compare and communicate. The danger is that when things are complicated, you often see whatever it is you are looking for. If a bunch of investors are looking for the best companies, and they define that as something that gives a return of 15-20%, you can be sure most of their models will spit out 15-20%. You don’t really understand risk if you then use that to rank various different analysts’ work. Your 20% is not my 20%. My 20% is not even my 20%. Add a couple of decimal places, and you realise that 36.79% of numbers are made up. Having a summary number doesn’t give you a full understanding of risk. Doing the work gives you a clue. Getting things wrong gives you a clue. 

your Twenty my Twenty

 

Extended Challenges

When a country isn’t wealthy enough (e.g. South Africa), or even if a country is wealthy enough (e.g. the United Kingdom), to have a solid safety net, we start pushing responsibility to owners and managers saying, “they need to look after the employees and create jobs.” In some ways, I think that is fair. Firms can use team language when convenient and treat people (employees and clients) as disposable tools at other times. The danger with that is the condescending idea that there is a class of people responsible for looking after people, and an underclass of dependents doing their bidding for a hand-to-mouth living. Both decision-making and responsibility can be shared in a way consistent with autonomy and consent. If we build proper resilience and endurance. If we aren’t solely reliant on salaries or welfare. What happens when companies go bust? What happens when countries can’t tax more or borrow more? As we have seen during the Covid crisis, a large number of the institutions we rely on are not designed for extended periods of challenge. To be creative, you need the capacity to survive the winter. Wealth creation is at its heart, risk management. 

Ice Age Earth

Decision Maker with Money

My first job after university was in Risk Product Development. My focus area was Earning Ability. Money is made by solving problems for decision-makers with money. In a hand-to-mouth economy, without capital-backed decision-making, you only get to make decisions on how to spend money if you have earned it from another decision-maker. First, you have to find a job. Then you have to do a job. Then you gradually get breathing space if you get paid more than you need to spend. When you venture into the land of discretionary (by choice) spending. Then you can either consume that money or put it to work. To start, you are at risk. Unless you have someone to turn to, there is the danger that something goes wrong, and you cannot work. Something goes wrong, and you cannot do your daily tasks. Something goes wrong, and you cannot do the work you were trained to do. Or you cannot do any work. The question “How much capital would I need if I couldn’t work?” is the starting point for the target size of the Engine you need to make your own decisions. Until then, something might go wrong.

Three-Horsepower Engine

Spin the Coin

Waves of randomness batter individuals the hardest. Our best efforts can be swamped by chance, and the lotteries of birth – geography, genetics, community, time. Take a big step back, and you lose and gain information. Spin a coin once, and you have no idea whether it will be heads or tails with confidence. Spin it a million times, and if the coin is fair, it will be a hair’s breadth from half a million of each. One way to control for unwanted noise is to pool the risk. Let your fate be decided by the million spins, rather than the one. Be part of a group. To accept that, you must accept the cross subsidies. A Cross Subsidy is where one group of consumers pay a higher price, so that another group pay an artificially lower price. It is like splitting the bill. The question is when you will care enough about the container to be okay with splitting. If you intentionally had salad and water, you are going to be bitter about paying for steak and champagne. Understandable. That is different from voluntarily acknowledging the coin of life has treated you well, and chipping into the container of 7.8 billion individual spins. Even though you already know the result, and can pretend it is merit.