Mid-Afternoon Musings on Risk
I first heard the Serenity Prayer in 1990, when the Irish punk balladeer Sinead O’Conner used it to open her platinum-selling protest Album “I Do Not Want What I Haven’t Got”. Her version - Lord, grant me the serenity to accept the things I cannot change, the courage to change the things I can, and the wisdom to know the difference - immediately altered the way I perceived the world. At the risk of exaggerating its influence, it contributed to a set of mental models that shaped my career.
As investors, we are challenged to understand the difference between things we can change and things we must accept, between things we can control and things we only wish we could. Interest rates. The price of oil. Geopolitical tension. Regulations. Demographics. Market disruptors. Fraud. Innovation. Terrorist attacks. Our own behavior.
As impact investors, on the other hand, we are inspired to change a raft of things that most investors unquestioningly accept. Perpetual poverty at the base of the economic pyramid? Permanent opportunity inequality? Climate weirding? Chronic food insecurity for marginalized communities? A spiraling housing crisis? Environmental degradation?
Conventional investors typically see outcomes like these as inconvenient facets of a system that, in general, works pretty well. Impact investors have the wisdom to see them as “things that can be changed”... and the courage to pursue that change.
The list of variables that affect our investments is, literally, endless. And our ability to influence most of them is, basically, non-existent. But there is one constant: pursuing financial return requires that we accept risk. Even the so-called “risk free return” available via US treasuries carries the risk of default. (While that risk is low, it isn’t zero… as the recent, operatic dysfunction in DC has revealed).
There is one risk variable that is entirely within our control: exposure. Risk structuring is the one element of a portfolio that is dynamic, flexible and responsive, and that informs possible future financial returns. The difficulty in risk structuring is that risk moves from abstraction to reality without warning. Even professional investors sometimes imagine they can tolerate elevated risk until they experience it. See 2008’s Great Financial Crisis.
Take, for example, the shocking escalation of long-simmering tensions between Israel and Palestine, tension that has boiled over more than once since Israel was founded in 1948. Setting aside the bewildering geopolitical and tragic humanitarian dimensions, as investors, we are fully aware of the fact of this risk.
Usually, it is a background risk, one that has no material effect on our portfolios. We accept it almost without thinking.
Sometimes, it becomes a foreground risk (as it is right now), that can indirectly affect our portfolios. A model for this would be the First Intifada in the late 80’s.
Rarely, it carries the risk of a much larger risk, one that has the potential to shift the investing landscape. Think of the Yom Kippur war in 1973, which led to the strengthening of OPEC and the oil shocks that punctuated that decade.
Whether or not the current conflagration carries this third level of risk remains to be seen. Thus far, just over a month after Hamas’ attack, market responses have been relatively muted. Oil has been volatile, but broadly flat. Gold has risen by about 10%. The Israeli Investable Market Index (IIMI) has declined about 15%. But since the IIMI represents less than .2% of the MSCI All-Country World Index, that drop has had virtually no effect on global investors. More recently, US markets have begun to reflect anxiety about the conflict spreading, and are now down about 5% since the October 7 attack.
Market shocks will always be a feature of any investor’s journey. I was a keen market participant on Black Monday and a young advisor during the interest rate crisis in 1994. I dodged the worst of the dotcom implosion, sat stunned before my monitors on 9/11, watched three US-led wars unfold, stayed solvent through the Great Financial Crisis, and was able to be opportunistic during the Covid Correction. Had I retreated after any one of those, my career (and my portfolio) would have been very different.
This is not to say that we dismiss the potential implications of elevated risk. Risk is always part of investing. But we are mindful of the type of risk that we accept, the amount of risk that we build into portfolios, and the duration of that risk, all in service of supporting the lives that our clients live.
And - again specifically relative to impact investing, one part of what makes Align unique is our deep understanding of the unconventional risks embedded in collaboratively building a world that works for all 8 billion of us.